<PAGE>   1

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

                                    FORM 10-K

                Annual Report Pursuant to Section 13 or 15(d) of
                       The Securities Exchange Act of 1934

                   FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998

                        Commission file number 0001066284

                                 --------------

                               CELL PATHWAYS, INC.
             (Exact name of Registrant as specified in its charter)

<TABLE>
<S>                               <C>                                        <C>       
            DELAWARE                       702 ELECTRONIC DRIVE                  23-2969600
(State or other jurisdiction of              HORSHAM, PA 19044                (I.R.S. Employer
 incorporation or organization)   (Address of principal executive offices)   Identification No.)
</TABLE>

                                 (215) 706-3800
                         (Registrant's telephone number,
                              including area code)

                                ----------------

           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 Per Share
                         Preferred Stock Purchase Rights
                                (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 (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.

                                Yes  X     No
                                    ---       ---

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

     The aggregate market value of the voting stock held by non-affiliates of
the Registrant as of March 1, 1999 was approximately $139,238,000, based upon
the last reported sales price of the Registrant's Common Stock on the Nasdaq
National Market.

     As of March 1,1999 there were 24,315,013 shares of the Registrant's Common
Stock outstanding.

                              ---------------------

                       DOCUMENTS INCORPORATED BY REFERENCE

     Portions of the Proxy Statement relating to the Annual Meeting of
Stockholders to be held on June 22, 1999, are incorporated by reference into
Part III of this report. Other documents incorporated by reference are listed in
the Exhibit Index.
<PAGE>   2
                               CELL PATHWAYS, INC.
                                    FORM 10-K

<TABLE>
<S>         <C>                                                                <C>
Part I   
  Item 1.   Business.........................................................   1
            Overview.........................................................   1
            Business Strategy................................................   2
            Carcinogenesis...................................................   2
            CPI Technology...................................................   3
            Products in Development..........................................   5
            National Cancer Institute and Other Third-Party Arrangements.....  12
            Scientific Advisory Board........................................  13
            Patents, Trademarks and Proprietary Technology...................  14
            Competition......................................................  16
            Government Regulation............................................  17
            Manufacturing....................................................  20
            Marketing and Sales..............................................  20
            Employees........................................................  21
            Executive Officers and Key Employees.............................  21
            Risk Factors.....................................................  23
  Item 2.   Properties.......................................................  30
  Item 3.   Legal Proceedings................................................  30
  Item 4.   Submission of Matters to a Vote of Security Holders..............  31
Part II  
  Item 5.   Market for the Registrant's Common Equity and Related
            Stockholder Matters..............................................  32
  Item 6.   Selected Financial Data..........................................  33
  Item 7.   Management's Discussion and Analysis of Financial
            Condition and Results of Operations..............................  33
  Item 7A.  Quantitative and Qualitative Disclosures About Market Risk.......  38
  Item 8.   Financial Statements and Supplementary Data......................  38
  Item 9.   Changes in and Disagreements with Accountants on Accounting
            and Financial Disclosures........................................  38
Part III 
  Item 10.  Directors and Executive Officers of the Registrant................ 39
  Item 11.  Executive Compensation...........................................  39
  Item 12.  Security Ownership of Certain Beneficial Owners and Management...  39
  Item 13.  Certain Relationships and Related Transactions...................  39
Part IV  
  Item 14.  Exhibits, Financial Statement Schedules and Reports on Form 8-K..  40

  Signatures.................................................................  42
</TABLE>
<PAGE>   3
                                     PART I

ITEM 1.  BUSINESS

         Certain statements made in this report, and oral statements made with
respect to this report, constitute "forward-looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995. Such statements
include those which express plan, anticipation, intent, estimation, belief,
contingency or future development and/or otherwise are not statements of
historical fact. These statements are subject to risks and uncertainties, known
and unknown, which could cause actual results and developments to differ
materially from those expressed or implied in such statements. Such risks and
uncertainties relate to, among other factors, the costs, delays and
uncertainties inherent in basic pharmaceutical research, drug development and
clinical trials; the uncertainty of obtaining regulatory approval, and the
timing and scope of any approval received; acceptance by providers of healthcare
reimbursement; the validity, scope and enforceability of patents; the actions of
competitors; dependence upon third parties; product liability; and other risks
detailed in Cell Pathways, Inc. reports filed under the Securities Exchange Act
of 1934, including the section under Item 1 of this report entitled "Risk
Factors". The Company undertakes no obligation to update or revise the
statements made in this report.

OVERVIEW

         Cell Pathways, Inc. was incorporated in Delaware in July 1998 as a
subsidiary of, and as of November 3, 1998, successor to, a Delaware corporation
of the same name. As the context requires, "CPI" or the "Company" is used herein
to signify the successor and/or the predecessor corporations.

         CPI is a pharmaceutical company focused on the research, development
and commercialization of products to prevent cancer and to treat cancer. CPI's
technology may also prove to have applicability beyond the field of cancer.

         The Company's technology is based upon its discovery of a novel
mechanism which the Company believes, based on its research, can be targeted to
induce selective apoptosis, or programmed cell death, in precancerous and
cancerous cells without affecting normal cells. CPI has created a new class of
selective apoptotic anti-neoplastic drugs ("SAANDS") and has synthesized over
500 new chemical compounds in this new class. In screening assays, over 200 of
these new compounds display significantly greater apoptotic potency than CPI's
lead drug candidate, PREVATAC(TM) exisulind.

         CPI commenced clinical trials of its lead compound, PREVATAC(TM)
exisulind (previously known as FGN-1(TM) exisulind), in 1994. By 1997, that
clinical trial program had expanded to include several indications. In December
1998, CPI filed an investigational new drug application ("IND") with the Food
and Drug Administration ("FDA") in order to commence the clinical trial program
of a second compound, CP 461. Description of these clinical trials is set forth
below under "Products in Development." PREVATAC(TM) exisulind and CP 461 are the
only product candidates for which the Company has filed an IND and which during
1999 the Company expects to be studying in clinical trials.


                                       1
<PAGE>   4
BUSINESS STRATEGY

         CPI's objectives are to be a leader in the development of
pharmaceutical products to prevent cancer and to treat cancer, and to build an
integrated pharmaceutical company focused on the oncology market. To meet these
objectives CPI intends to:

                  -        Pursue accelerated clinical development of
                           PREVATAC(TM) exisulind, initially in indications
                           where small clinical trials with clear endpoints may
                           yield statistically significant results.

                  -        Utilize CPI's proprietary technology to develop
                           additional SAANDS such as CP 461 for cancer therapy
                           and for cancer chemoprevention.

                  -        Commercialize products directly to focused physician
                           groups. CPI intends to establish its own focused
                           sales force to promote products in the U.S. targeted
                           at diseases that are treated by relatively small,
                           well-defined groups of physicians.

                  -        Develop strategic collaborations for research,
                           development and/or commercialization. CPI will seek
                           to establish strategic relationships for the
                           development and commercialization of potential
                           products for indications that would require
                           significant development resources and/or significant
                           marketing and sales resources. CPI is seeking
                           partners for international development and
                           commercialization of potential products.

                  -        Selectively and opportunistically acquire
                           technologies, products and/or companies devoted to
                           the prevention, diagnosis and treatment of cancer.

CARCINOGENESIS

         Cancer results from a sequence of changes involving the genes of cells
which eventually leads to abnormal and uncontrolled cell proliferation. This
multi-stage process is known as carcinogenesis and generally results from a
combination of factors which occur over a period of years. Certain factors, such
as inherited genetic defects, are present at birth. Other factors that may
contribute to carcinogenesis include environmental exposures and the aging
process. Carcinogenesis is first recognized clinically when abnormal cells
become visible to a screening procedure or reach a size or location sufficient
to create clinical signs and symptoms. The clinical emergence may occur many
years following the events which first initiated carcinogenesis. Generally,
cells characterized by abnormal growth that may lead to cancer but have not yet
invaded surrounding tissue are termed precancerous.

         Precancerous Lesions. Many cancers are preceded by precancerous
lesions, which are accumulations of abnormal cells. Because precancerous lesions
are usually asymptomatic, the ability to identify and monitor them and to
intervene clinically before the possible development of cancer is dependent upon
diagnostic screening tests. Recent years have seen broader applications of
screening tests which have varying degrees of reliability and predictability.
These screening tests include the Pap smear, flexible sigmoidoscopy and the
Prostate Specific Antigen ("PSA") test. In addition, there have been recent
advances in genetic screening, such as the BRCA1 and BRCA2 tests to detect
individuals with a higher risk of developing breast cancer in the future.

         Precancerous lesions are most often diagnosed in epithelial tissues,
such as the skin or the inside surface of organs, including the intestine,
cervix, bladder and prostate. The following table lists examples of epithelial
precancerous lesions, the types of cancer to which such lesions can progress and
the diagnostic screening tests currently in use to detect such lesions.


                                       2
<PAGE>   5
                   EXAMPLES OF EPITHELIAL PRECANCEROUS LESIONS
<TABLE>
<CAPTION>
                                                           CONVENTIONAL
TYPE OF LESION                        RELATED CANCER   METHOD OF DIAGNOSIS
--------------                        --------------   -------------------
<S>                                   <C>              <C>
Actinic Keratosis                     Skin             Visual examination

Adenomatous Colonic Polyp             Colorectal       Endoscopy (sigmoidoscopy
                                                       or colonoscopy)

Barrett's Esophagus                   Esophageal       Endoscopy (esophagogastroscopy)
Bronchial or Lung Dysplasia           Lung             Sputum cytology
Cervical Intraepithelial Neoplasia    Cervical         Papanicolau (Pap) smear

Prostatic Intraepithelial Neoplasia   Prostate         Prostate Specific Antigen (PSA)
                                                       and digital rectal examination

Transitional Cell Carcinoma
in situ (earliest stage)              Bladder          Cystoscopy
</TABLE>

         Patients with precancerous lesions are advised to follow a program of
regular monitoring and removal of lesions where appropriate. However, existing
techniques for treating precancerous lesions are often expensive, have
undesirable side effects or are of limited effectiveness. Endoscopic or surgical
removal can be effective for single lesions, but risks and costs increase
significantly if lesions recur, if there are numerous lesions or if lesions
occur in less accessible tissues. Because of their significant side effects,
systemic administration of most existing chemotherapeutic drugs is not
appropriate for treating precancerous lesions. Reduction of environmental risks
or change in diet are generally more effective in preventing the early stages of
carcinogenesis than in arresting or reversing the changes that occur in the
later stages of carcinogenesis. As a result of the inadequacy of current
treatments, there is a significant need for the development of new therapeutics
to treat precancerous lesions. If left untreated and not reversed by natural
processes, precancerous lesions may progress to cancer.

         Cancer. The American Cancer Society estimates that over 1.4 million new
cases of cancer were diagnosed and approximately 560,000 cancer deaths occurred
in the U.S. in 1997. Cancer is the second leading cause of death in the U.S.,
and approximately ten million people living in the U.S. have a history with
cancer. Due in part to the development of new diagnostic procedures, the highest
number of new cancer diagnoses are currently occurring in the prostate, breast,
lung and colon/rectum, representing approximately 50% of all new cancer cases.

         Cancer is generally treated by attempting to remove the cancerous
cells, either by surgery or by chemical or radiation therapies. Currently
available chemotherapies and radiation therapies target all rapidly dividing
cells, both cancerous and healthy, and therefore result in serious side effects.
The limited efficacy and harmful side effects of existing cancer treatments and
the costs associated with managing these side effects continue to drive the
search for new therapies.

CPI TECHNOLOGY

         To address the need for new therapies, CPI's technology focuses on the
selective induction of apoptosis in cells that manifest abnormal growth
(neoplastic cells), such as precancerous and cancerous cells. Apoptosis is a
naturally occurring physiological process in which a number of components inside
the cell "program" the cell to die without causing harm to surrounding cells.
Apoptosis occurs in tissues that are continually renewing themselves, such as
the lining of the digestive system, or as a natural defense mechanism that
prevents the replication of cells that have undergone DNA damage. CPI's
technology is based upon its discovery of a novel mechanism which CPI believes,
based on its research, can be targeted to induce selective apoptosis in
neoplastic cells without affecting normal cells.


                                       3
<PAGE>   6
         Many existing chemotherapeutic agents as well as radiation induce
apoptosis in rapidly proliferating cells without differentiating between
neoplastic cells and normal cells. This can result in toxicity, including
suppression of the immune system, hair loss and gastrointestinal disturbances.
As a result of this toxicity, most existing chemotherapeutic agents and
radiation therapy are not appropriate for treating precancerous lesions in
otherwise healthy individuals for whom safety and tolerability are essential for
chronic or extended therapeutic use.

         Conventional Induction of Apoptosis in Cancer Therapy. Radiation
therapy and many existing chemotherapeutic agents act on proliferating cells by
disrupting cellular DNA synthesis to induce apoptosis. Once significant damage
occurs to the DNA, a process is initiated that is controlled by the gatekeeper
protein p53 and modulated by various proteins such as bax and bcl-2. This
process results in the activation of caspases, a family of enzymes that is
involved in the apoptotic process, which trigger a cascade of events resulting
in apoptosis. The end result of apoptosis is the dismantling of the cell into
apoptotic vesicles, which are naturally cleared by the body. The apoptotic
mechanism identified by CPI does not appear to involve p53, or the modulator
proteins, such as bax or bcl-2.

         Discovery of Novel Apoptotic Mechanism. CPI believes it has discovered
a previously undefined mechanism for regulating apoptosis. Research suggests
that two key elements of this mechanism include cyclic GMP ("cGMP") which is
generated by enzymatic conversion of GTP to cGMP by guanyl cyclase initiated by
naturally-occurring triggers, and a novel cGMP phosphodiesterase ("PDE") which
plays a key role in controlling the intracellular levels of cGMP. CPI has
determined in a limited number of colon cancer patients that the neoplastic
tissue has a higher level of cGMP PDE activity than neighboring normal tissue,
which may prevent neoplastic cells from responding to normal signals that
trigger apoptosis. When the novel cGMP PDE's activity increases, as in
neoplastic cells, cGMP levels are reduced and activation of a critical
downstream protein, protein kinase G, is interrupted, subsequently preventing
the activation of the caspases and apoptosis.

         Selective Induction of Apoptosis by CPI Compounds. Research suggests
that CPI's compounds, including PREVATAC(TM) exisulind and CP 461, are targeted
at inhibiting the novel cGMP PDE's activity in neoplastic cells. CPI compounds
reduce cGMP PDE activity, thereby preventing the novel cGMP PDE from degrading
cGMP. Research suggests that cGMP is then available to trigger a critical
downstream protein which leads to the activation of caspases. As in the case of
conventional cancer treatment, caspases then trigger a cascade of events leading
to apoptosis.

         Research and Development Activities. CPI's scientist's have identified
intracellular proteins targeted by PREVATAC(TM) exisulind and have made
significant progress in characterizing the target protein. CPI has developed
pharmaceutical, immunological and molecular biologic probes that may be used to
identify additional indications to be targeted and to develop diagnostic tools.
CPI continues to identify additional elements involved in regulating the newly
identified apoptotic mechanism. CPI plans to investigate the potential
applicability of its novel apoptotic mechanism to hyperproliferative,
hypoproliferative and other disease conditions. There can be no assurance that
CPI's investigation will be successful.

         Utilizing its understanding of chemical structure and biological
activity, CPI has created a new class of SAANDS and, within this new class of
drugs, has synthesized over 500 new chemical compounds in five chemical families
and over 27 chemical classes. CPI's new compounds are tested for inhibitory
effects on the growth of cancer cells in vitro, for the induction of apoptosis
and for activity against the intracellular target, the novel cGMP PDE. Over 200
of the newly synthesized compounds display significantly greater apoptotic
potency than PREVATAC(TM) exisulind in these tests.

         A number of CPI compounds have shown activity against in vitro cultures
of immortalized cell lines of transplantable human cancers of the breast, colon,
lung and prostate. Preliminary results of studies with CPI's compounds in
short-lived primary cultures of human cancers obtained from individual patients
have shown activity against breast cancer. Using this data, CPI has evaluated
several new chemical entities ("NCEs"), filed an IND in December 1998 with
respect to one of them, CP 461, as its next product development candidate, and
is continuing its evaluation of other compounds as potential product 


                                       4
<PAGE>   7
development candidates. Significant additional preclinical and clinical trials
are necessary to determine the activity and utility of any product development
candidate. See "Risk Factors - Early Stage of Development; Absence of Developed
Products; Uncertainty of Clinical Trials."

         CPI plans to leverage its understanding of the structure-activity
relationship of CPI's compounds, and to expand its proprietary chemical library,
through combinatorial chemistry techniques and high-throughput screening
systems. CPI has contracted with outside firms to create or purchase targeted
chemical libraries including diverse chemical classes. CPI is screening these
compounds in order to identify additional potential lead compounds.

PRODUCTS IN DEVELOPMENT

         CPI is developing a family of product candidates, SAANDS, targeted at
the treatment and management of precancerous lesions and cancer. CPI's lead
compound in this family of new drugs, PREVATAC(TM) exisulind, is a sulfone
derivative of the nonsteroidal anti-inflammatory drug ("NSAID") sulindac.
PREVATAC(TM) exisulind is not an NSAID and lacks the anti-cyclooxygenase
activity that is associated with the serious gastrointestinal and renal side
effects observed with NSAID use.

         Clinical studies of PREVATAC(TM) exisulind commenced in 1994. Clinical
studies of CP 461 are expected to commence in the second quarter of 1999. These
are the only two product candidates which the Company expects to have in
clinical studies during 1999. In July 1998, PREVATAC(TM) exisulind was
designated by the FDA for Fast Track review for the treatment of APC (discussed
below). There can be no assurance as to if or when CPI will file a New Drug
Application ("NDA") seeking marketing approval for PREVATAC(TM) exisulind, or CP
461, or any other product candidate or compound, for any disease indication,
including those indications discussed below. Nor, with respect to any disease
indication, including those indications discussed below, can there be assurance
as to which additional clinical trials may need to be conducted prior to the
filing of an NDA for that indication.

         Despite the growing number of clinical trials, the clinical testing of
PREVATAC(TM) exisulind has involved only a limited number of patients, and the
clinical testing of CP 461 will not start until the second quarter of 1999.
Results obtained from studying a compound in any clinical trial are not
necessarily predictive of the results of the same compound (or of any other
compound) in other clinical trials, whether for the same indication or for other
indications. See, below, "Risk Factors - Early Stage of Development; Absence of
Developed Products; Uncertainty of Clinical Trials."


                                       5
<PAGE>   8
                           PREVATAC(TM) EXISULIND DEVELOPMENT PROGRAM

<TABLE>
<CAPTION>
INDICATION
PRECANCER                                   CLINICAL DEVELOPMENT STATUS(1)
---------                                   ------------------------------
<S>                                         <C>
Adenomatous Polyposis Coli...............   Fast Track Designation obtained 3Q 1998.  Pivotal Phase III trial
                                            completed January 1999; see description in text below. Phase I/II
                                            trial completed in 1Q 1997.  Orphan Drug status obtained 1Q 1994.

Sporadic Adenomatous Colonic Polyps......   Pivotal Phase II/III trial initiated in 4Q 1997; recruitment
                                            expected to complete 2Q 1999. Phase IB trial completed in 3Q 1997.

Barrett's Esophagus......................   Phase II trial recruiting early 1999.

Bronchial Dysplasia......................   Phase II trial may commence in 1999 but has not yet been
                                            scheduled; see description in text below.

Cervical Dysplasia.......................   Phase IB trial completed in 3Q 1997. Next trial not yet scheduled.

CANCER
------

Prostate Cancer Recurrence...............   Phase II/III trial expected to be completed 3Q 1999.

Lung Cancer..............................   Pilot study (9 patients) completed.  Phase II
                                            study expected to commence in 2Q 1999

Breast Cancer Recurrence.................   Pivotal Phase II/III trial initiated in 1Q 1998; Still recruiting;
                                            See description in text below.
</TABLE>
                           CP 461 CLINICAL TRIAL PROGRAM
<TABLE>
<CAPTION>
INDICATION                                  CLINICAL DEVELOPMENT STATUS (1)
----------                                  -------------------------------
<S>                                         <C>
Cancer Indications.......................   IND filed December 1998. Phase I
                                            safety trial expected to commence 2Q
                                            1999.

                                            Phase II study planned for 3Q 1999.
</TABLE>

(1)  The steps required before a drug may be marketed in the U.S. include: (i)
     preclinical laboratory and animal tests; (ii) submission to the FDA of an
     application for an INDexemption, which must become effective before human
     clinical trials commence; (iii) human clinical trials to establish the
     safety and efficacy of the drug, typically proceeding in three phases; (iv)
     submission of a detailed NDA to the FDA; and (v)FDA approval of the NDA.

     A "pivotal" study is a clinical trial used as primary evidence of safety
     and efficacy. More than one pivotal study may be necessary to gain
     marketing approval from the FDA.

     Clinical trials proceed through three phases, which may overlap in design
     and objective:

     "Phase I" trials involve the initial introduction of an investigational new
     drug into humans and are designed to test for tolerance and side effects
     and to determine the metabolic and pharmocologic actions of the drug in
     humans.

     "Phase IB" denotes a later stage Phase I study.

     "Phase II" involves clinical studies conducted in a limited number of
     patients to evaluate preliminarily the effectiveness of the drug for a
     particular indication and to determine the optimal dosage and the common
     short-term side effects and risks.

     "Phase III" involves expanded studies to evaluate the safety and 
     effectiveness of the drug.


                                       6
<PAGE>   9
         CPI's current clinical trial strategy seeks to identify subsets of
patient populations for the various targeted indications where the endpoints of
clinical trials occur in high frequency or in a relatively short time frame.
Because CPI is studying PREVATAC(TM) exisulind for multiple indications, CPI
plans to utilize safety and pharmacokinetic data obtained in clinical trials
already completed to provide a basis for commencing more advanced clinical
trials in other indications. CPI believes that this strategy of designing
clinical trials around selected populations and utilizing existing safety data
may allow CPI to reduce the duration of clinical trials and the number of test
subjects enrolled in its clinical trials, thereby generating statistically
significant clinical results more quickly and cost-effectively.

         Clinical Development of PREVATAC(TM) exisulind for Precancerous
Lesions. Based on PREVATAC(TM) exisulind's safety profile, CPI believes that the
compound may be useful in treating patients with precancerous lesions for whom a
drug's long-term safety profile is important. CPI is pursuing the clinical
development of PREVATAC(TM) exisulind for several types of precancerous
conditions, as described below.

         Adenomatous Polyposis Coli. APC is an inherited disease characterized
by the development of hundreds to thousands of adenomatous polyps in the colon
and the progression to colon cancer if left untreated. This disease can be
confirmed within a family by genetic testing. Most APC patients must be
endoscopically screened beginning in their teenage years and must have a
substantial portion of their large intestine removed by age 20. Even with this
treatment, these patients continue to develop polyps in the remaining rectal
tissue and are typically monitored by endoscopy two to four times each year. It
is anticipated that polyps will be removed at each examination. CPI's clinical
program is testing PREVATAC(TM) exisulind both in patients who previously have
had most of their large intestine removed, leaving the rectum intact (sub-total
colectomy), and in the pediatric population whose colons have not been removed.

         It is estimated that APC occurs in between 8,000 and 36,000 persons in
the United States. Because of the large number of lesions that occur in these
patients and the continuous development of new lesions with, characteristically,
no spontaneous remission, CPI has believed that clinical trials in APC can be
conducted in, and statistically significant results obtained from, a relatively
small number of patients.

         In a Phase I/II polyp regression study conducted with the support of
the National Cancer Institute at the Cleveland Clinic Foundation, 18 APC
patients were treated with PREVATAC(TM) exisulind for six months. The study was
commenced in August 1995 and its extension was completed in January 1997; it was
designed to observe the safety and pharmacokinetics of increasing doses of
PREVATAC(TM) exisulind. No serious adverse events attributable to PREVATAC(TM)
exisulind were reported at the clinically effective doses of 400-600 milligrams
total daily dose. At the 800 milligram total daily dose level, four out of six
patients displayed asymptomatic reversible elevations of liver enzymes; all of
such patients continued in the trial at lower dose levels. At the end of the
study, all 18 patients elected to continue taking the drug in an extension
study, and the majority of the patients have been on the drug for more than 36
months. No patient has withdrawn from the study or its extension due to serious
adverse events.

         In the Phase I/II study and its extension, nearly all patients were
observed to experience a marked reduction in the number and size of exophytic
(i.e., raised over the surface) precancerous rectal polyps that were six
millimeters or less in diameter at the beginning of the study. The effect was
observed to be correlated to dosage, with 600 milligrams per day having a
significantly more pronounced effect than 400 milligrams per day. In the
extended study, no progressive increase in polyp size or volume was observed in
13 of the 15 patients who have remained in the study and have been maintained on
the optimal dose.

         Following treatment with PREVATAC(TM) exisulind in the Phase I/II
study, examination of certain regressing polyps showed substantial increases in
the rate of apoptosis (as compared with the rate of apoptosis of untreated
polyps at the beginning of the study) while the rate of apoptosis in nearby
normal tissue was unchanged, suggesting that PREVATAC(TM) exisulind selectively
induces apoptosis in neoplastic cells without affecting normal cells.


                                       7
<PAGE>   10
         In July 1998, the FDA granted PREVATAC(TM) exisulind Fast Track
designation for expedited review for APC. The Fast Track Program is a new
mechanism, introduced in the FDA Modernization Act of 1997, for facilitating the
development and expediting the approval of drugs that demonstrate the potential
to address unmet medical needs for serious and life-threatening conditions. This
mechanism builds upon existing FDA programs for accelerated approval.

         In January of 1999, CPI completed a double-blind, placebo-controlled
pivotal Phase III study of PREVATAC(TM) exisulind in APC. The study was
conducted at centers in the U.S., Sweden, the United Kingdom and Israel. Of the
74 patients enrolled in the study, 65 completed the one-year course of drug (or
placebo) treatment. The primary endpoint of the study was a statistical
comparison of the formation of new polyps (as measured by periodic polyp
fulgeration) in drug treated patients as compared with patients receiving
placebo. Preliminary evaluation of the unblinded data from this trial suggested
that the study did not achieve statistical significance. On February 1, 1999,
the Company announced that it anticipated a delay in the filing of an NDA with
the FDA for APC and that the Company would be evaluating the data in a process
which was expected to continue for some weeks. In the press release the Company
also stated that the preliminary evaluation appeared inconsistent with data from
the previous Phase I/II and extension studies as well as from studies in animal
models and cell culture systems. The preliminary evaluation was an adverse
development; following its announcement by the Company, the market price of the
Company's common stock declined substantially. As of March 26, 1999, the Company
had not completed its evaluation of the data from the Phase III trial and had
not formulated its further plans with respect to the filing of an NDA for APC.

         In January 1998, CPI initiated an APC study of PREVATAC(TM) exisulind
utilizing a protocol identical to the pivotal Phase III study to gather
additional patient data; 26 patients are enrolled in this study. In another
concurrent APC study, CPI enrolled eight patients with high rates of recurrence
of polyps who would have been excluded from the pivotal Phase III study.

         Also in 1998, CPI commenced a safety study of PREVATAC(TM) exisulind in
six pediatric APC patients. Based upon observations during this study, the
Company is planning a Phase II open label study in twenty pediatric patients;
this trial is expected to commence during the second quarter of 1999.

         Patients with APC are usually managed by gastroenterologists and
colorectal surgeons. There are approximately 9,500 gastroenterologists and 1,000
colorectal surgeons in the U.S. CPI believes that a subset of these physicians
may treat a significant portion of the APC patients. If CPI files an NDA for APC
and is granted marketing approval for this indication, CPI intends to focus its
marketing efforts on these physicians.

         Following conclusion of the Phase III study in APC, most of the
patients who were on drug are being continued on drug and most of the patients
who were on placebo have elected to cross over onto drug treatment. Also
continuing on drug treatment are 12 of the patients from the Phase I/II Study
and extensions, as well as the patients in the continuing APC trials described
above.

         There can be no assurance as to if or when an NDA will be filed for the
APC indication or, if filed, as to if or when the FDA will find that
PREVATAC(TM) exisulind, on the basis of any or all of the studies which have
been conducted or may hereafter be conducted, is sufficiently safe and effective
to warrant marketing approval by the FDA for APC (or for any other indication).

         Sporadic Adenomatous Colonic Polyps. Sporadic adenomatous colonic
polyps are relatively common precancerous lesions occurring in the large
intestine. These polyps are histologically, microscopically and genetically
indistinguishable from the polyps of APC. More than 30% of people in the U.S.
over the age of 50 have sporadic adenomatous colonic polyps. Most of these
people will develop only one or two polyps and once the polyps are removed will
not require significant ongoing medical attention. There are, however, subgroups
of people at higher than usual risk of developing colorectal cancer who should
be monitored frequently. These patients include people with close relatives that
have had colorectal cancer, people over age 60 and people with multiple polyps
or polyps which are large or severely dysplastic or which recur frequently. CPI
is targeting these patients for clinical studies and chemopreventive therapy.


                                       8
<PAGE>   11
         The American Cancer Society, American College of Gastroenterology,
American Gastroenterological Association and other expert organizations
recommend that all people over the age of 50 be screened for precancerous
colonic polyps and colon cancer. This recommendation is not followed universally
and, as a result, a large number of people whose polyps have not been detected
are at risk of developing colon cancer. The procedure for screening for sporadic
adenomatous colonic polyps is an endoscopic examination of the lower part of the
large intestine. This procedure, a sigmoidoscopy, is performed by
gastroenterologists, internists and other physicians. For more extensive and
invasive examination of patients who have had polyps detected by sigmoidoscopy
and for the treatment of sporadic adenomatous colonic polyps, a colonoscopy is
performed, usually by a gastroenterologist.

         In September 1997, CPI completed a two-month Phase IB safety and
pharmacokinetic study in 18 patients who had a history of either sporadic
adenomatous colonic polyps or cervical dysplasia. CPI then initiated a one-year
multi-center, pivotal Phase II/III study in the regression of sporadic colonic
polyps. This study, initiated in December 1997, is a double-blind,
placebo-controlled study to evaluate the safety and efficacy of different doses
of PREVATAC(TM) exisulind in the treatment of existing sporadic adenomatous
colonic polyps. This 270 patient study is expected to be completely enrolled
during the second quarter of 1999. CPI may need to conduct further concurrent
studies of safety and pharmacokinetics. Additional efficacy studies may also be
required beyond that now underway.

         As is the case with all disease indications being studied in the
Company's clinical trials, there can be no assurance as to if and when an NDA
will be filed for the sporadic colonic indication or which additional trials may
be required prior to such filing or, if filed, as to if or when the FDA will
find that PREVATAC(TM) exisulind, on the basis of any or all of the studies
which have been conducted or may hereafter be conducted, is sufficiently safe
and effective to warrant marketing approval by the FDA for the treatment of
sporadic colonic polyps (or for any other indication).

         The 9,500 gastroenterologists and 1,000 colorectal surgeons in the U.S.
are primarily responsible for performing colonoscopies and managing treatment of
individuals who have sporadic adenomatous colonic polyps. This target audience
of physicians includes those who treat APC and is a logical extension of CPI's
planned marketing and sales efforts.

         Barrett's Esophagus. Barrett's Esophagus is a precancerous condition of
the lower esophagus characterized by progressive and readily identifiable
changes in the appearance of the lining of the esophagus or esophageal
epithelium. Some patients experience reflux of stomach acid into the esophagus,
exacerbating the condition. Patients with Barrett's Esophagus have 30 to 40
times greater risk of developing esophageal cancer than the average person.
Treatment with anti-acid therapy or other anti-reflux measures is usually not
effective. Approximately one percent of the U.S. population, or an estimated
2,000,000 people, have Barrett's Esophagus.

         In December of 1998, CPI initiated a 12-month Phase II study in
patients with Barrett's Esophagus to evaluate the safety and efficacy of
PREVATAC(TM) exisulind. CPI's proposed clinical endpoints are reduction in the
area affected or in the degree of dysplasia found in the affected tissues. This
25 patient study is expected to be fully enrolled by mid-1999. Depending upon
the data generated in this study, the Company may sponsor additional studies in
this disease indication.

         Barrett's Esophagus is diagnosed by upper gastrointestinal endoscopy, a
procedure usually performed by gastroenterologists. Treatment is usually managed
by gastroenterologists or by thoracic surgeons. There are approximately 2,000
thoracic surgeons in the U.S. Because of the significant overlap between the
physician groups who treat Barrett's Esophagus and those who treat APC and
sporadic adenomatous colonic polyps, CPI does not anticipate that any
significant increase in the sales and marketing organization will be required to
promote products for Barrett's Esophagus.

         Clinical testing of PREVATAC(TM) exisulind for Barrett's Esophagus is
at a very early stage. No safety or efficacy data has been obtained for this
indication. There can be no assurance as to if or when an NDA would ever be
filed for this indication or which additional trials may be required prior to
such filing 


                                       9
<PAGE>   12
or, if filed, as to if or when the FDA will find that PREVATAC(TM) exisulind, on
the basis of any or all of the studies which have been conducted or may
hereafter be conducted, is sufficiently safe and effective to warrant marketing
approval by the FDA for the treatment of Barrett's Esophagus (or for any other
indication).

         Bronchial Dysplasia. Bronchial dysplasia is a precancerous condition of
the lower respiratory tract characterized by progressive and readily
identifiable changes in the appearance of the lining of the bronchi of the lung
or bronchial epithelium. In the bronchial epithelium, smoking may initiate a
multi-step process that first appears histologically as dysplasia or metaplasia,
a biological precursor to lung cancer. Two-thirds of heavy smokers may develop
these precancerous lesions.

         CPI plans to initiate a Phase II/III study of PREVATAC(TM) exisulind in
patients with bronchial dysplasia. The proposed clinical endpoints would be
reduction in the area affected or in the degree of dysplasia found in the
affected tissues. Whether CPI will commence this study in 1999, or at all, will
depend upon a variety of factors including developments in other Company
programs and competing demands for limited resources.

         Pulmonary specialists and thoracic surgeons are primarily responsible
for performing bronchoscopies and managing treatment of individuals who have
bronchial dysplasia. There are approximately 8,400 of these physicians in the
U.S. If CPI develops PREVATAC(TM) exisulind or CP 461 or any other product
candidate to treat bronchial dysplasia, CPI anticipates marketing directly to
these focused physicians groups.

         Cervical Dysplasia. Cervical dysplasia is a relatively common
precancerous lesion of the cervix that is easily diagnosed by Pap smears. Fifty
million Pap smears are performed each year in the U.S., of which approximately
five percent reveal some form of cervical dysplasia. Although very few cases of
cervical dysplasia progress to cancer, it is estimated that in 1997 there were
approximately 14,000 new cases of cervical cancer in the U.S.

         In September 1997, CPI completed a two-month Phase IB safety and
pharmacokinetic study in 18 patients who had a history of sporadic adenomatous
colonic polyps or cervical dysplasia. CPI is designing a six-month cervical
dysplasia Phase II study to evaluate the safety and efficacy of different doses
of PREVATAC(TM) exisulind in reducing the size of the area affected by and
degree of dysplasia. When, if and in which locations CPI will initiate this
study will depend upon a variety of factors, including developments in other
Company programs and competing demands for limited resources.

         Treatment of cervical dysplasia, especially those cases with more
severe dysplasia or recurrence, is usually performed by gynecologists, of whom
there are approximately 36,000 in the U.S. If CPI determines to pursue this
market, CPI anticipates seeking a marketing partner for sales to this large
physician market.

         There can be no assurance as to if or when an NDA for PREVATAC(TM)
exisulind will be filed for any precancer indication, including those discussed
above, or, if filed, as to if or when the FDA will find that PREVATAC(TM)
exisulind, on the basis of any or all of the studies which have been conducted
or may hereafter be conducted, is sufficiently safe and effective to warrant
marketing approval by the FDA for any such indication.

         Clinical Development of PREVATAC(TM) exisulind for Cancerous Lesions.
Laboratory studies have demonstrated that PREVATAC(TM) exisulind arrests or
slows the progression of certain cancerous lesions. Based on the safety profile
of PREVATAC(TM) exisulind and its novel mechanism of activity, CPI believes that
PREVATAC(TM) exisulind may be clinically useful in augmenting radiation and
conventional chemotherapy in the treatment of cancers and the prevention of
recurrence. CPI believes that cancer cells that are resistant to radiation or
conventional chemotherapy may be killed by PREVATAC(TM) exisulind due to its
effect on an apoptotic mechanism that is different from that targeted by
conventional therapies. Results of clinical trials of PREVATAC(TM) exisulind in
the treatment of any precancer indication may not be 


                                       10
<PAGE>   13
predictive of the results that may be obtained from trials of PREVATAC(TM)
exisulind in the treatment of cancer. Also, data from human clinical studies of
PREVATAC(TM) exisulind in precancerous indications suggests that the appearances
of efficacy, if any, of the drug appear to become more noticeable when the drug
has been administered for a longer, rather than a shorter, period, suggesting to
investigators that, when a choice as to length of trial is presented, the longer
duration may be more indicative of the efficacy, if any, of the drug.

         Prostate Cancer. In in vitro and in vivo studies, CPI has observed that
PREVATAC(TM) exisulind inhibits growth of prostate cancer cells, including one
type of prostate cancer cell that is resistant to conventional chemotherapeutic
drugs. In August 1998, CPI completed enrollment of 96 patients in a one-year
Phase II/III clinical study for the prevention of prostate cancer recurrence.
This study involves men who have had a prostatectomy and have rising PSA levels,
which is often a sign of recurrent prostate cancer that is not detectable by
current imaging or diagnostic methods. The endpoint of this study is the arrest
or delay in the elevation of PSA. The study design permits an interim evaluation
of data from this study when all participants have completed half the study.
Noting that drug efficacy, if any, appears to become more noticeable with longer
drug exposure, and also noting the possibility of a statistical penalty which
might be involved if an interim analysis were performed, the Company may or may
not choose to invoke this design feature. The results obtained from this study,
which is expected to conclude in the third quarter of 1999, will influence the
Company's plans for further studies in prostate cancer.

         Prostate cancer is commonly diagnosed and treated by urologists, of
whom there are approximately 10,000 in the U.S. Oncologists, of whom there are
5,500 in the U.S., manage the chemotherapeutic treatment of prostate cancer. If
CPI develops and receives marketing approval for products to treat prostate
cancer, CPI anticipates marketing these products directly to urologists and
oncologists.

         Breast Cancer. It is estimated that in 1997 there were approximately
181,000 new cases of breast cancer in the U.S. CPI has observed that
PREVATAC(TM) exisulind and other CPI compounds show dose-related inhibitory
effects in several in vitro breast cancer cell systems, in in vivo
chemically-induced cancer models and in in vitro studies with primary breast
cancer tissues removed from patients. In February 1998, CPI initiated an
18-month double-blind, placebo controlled Phase II/III study to evaluate the
safety and efficacy of PREVATAC(TM) exisulind in the prevention of recurrence of
breast cancer in women who have had breast cancer twice, have not responded to
traditional recurrence prevention such as tamoxifen, and who are in second
remission after having been treated with conventional chemotherapeutic agents.
The study is designed to enroll 275 patients. As of March 1999, due to the
stringent enrollment criteria and the competition for patients, only 37 patients
had been enrolled. The Company has not yet determined whether or for how long to
keep open the enrollment in this study.

         Gynecologists usually diagnose breast cancer, while oncologists manage
the chemotherapeutic treatment. If CPI develops and receives marketing approval
for any products to treat breast cancer, CPI anticipates marketing these
products to oncologists.

         Lung Cancer. PREVATAC(TM) exisulind has shown positive results in the
prevention of chemically-induced lung cancer in rodents. CPI initiated a pilot
study of the safety and efficacy of PREVATAC(TM) exisulind in patients with
advanced lung cancer in December 1997. This exploratory study initially included
six patients and added three more patients. CPI is now making preparations to
terminate this pilot study and to commence a Phase II study in lung cancer. The
results obtained will influence CPI's plans for further studies in lung cancer

         Lung cancer may be diagnosed by general practitioners or internists.
Oncologists manage the chemotherapeutic treatment of lung cancer. If CPI
develops and receives marketing approval for products to treat lung cancer, CPI
anticipates marketing these products directly to oncologists.

         There can be no assurance as to if or when an NDA for PREVATAC(TM)
exisulind will be filed for any cancer indication, or which additional clinical
trials may be required for the submission of an NDA for 


                                       11
<PAGE>   14
a particular cancer indication, or, if an NDA is filed, as to if or when the FDA
will find that PREVATAC(TM) exisulind, on the basis of any or all of the studies
which have been conducted or may hereafter be conducted, is sufficiently safe
and effective to warrant marketing approval by the FDA for any such indication.

         Clinical Development of CP 461 for Cancer Treatment. CPI filed an IND
for CP 461 in December 1998 and plans to commence a Phase I study of this
compound in the second quarter of 1999. During 1999, CPI plans to commence one
or more Phase II studies in the treatment of cancer. The cancer indication or
indication(s) may be selected from among lung, prostate, breast and colon, based
upon the Company's evaluation of the likelihood of success of its SAANDs-based
approach at the time. When and if CPI will actually commence Phase II studies in
1999 will depend upon a variety of factors including the outcome of Phase I
studies, developments in other Company programs and competing demands for
limited resources.

         There can be no assurance that CPI will obtain marketing approval for
PREVATAC(TM) exisulind, or CP 461, or any other product candidate or compound,
for any indication. CPI does not anticipate filing an IND to permit clinical
testing of any other compound during 1999. Despite the growing number of
clinical trials, the clinical testing of PREVATAC(TM) exisulind has involved
only a limited number of patients, and clinical testing of CP 461will not
commence until the beginning of the second quarter of 1999. Results obtained
from studying a compound in any clinical trial are not necessarily predictive of
the results of the same compound (or of any other compound) in any other
clinical trial, whether for the same indication or for other indications. See,
below, "Risk Factors - Early Stage of Development; Absence of Developed
Products; Uncertainty of Clinical Trials."

NATIONAL CANCER INSTITUTE AND OTHER THIRD-PARTY ARRANGEMENTS

         Pursuant to a Clinical Trials Agreement entered into in 1994, the NCI
agreed to sponsor human clinical trials (including but not limited to safety and
efficacy testing) of PREVATAC(TM) exisulind for at least two precancer
indications. The first indication is colonic adenomas, including APC. The NCI
sponsored a portion of the Phase I/II clinical study for APC that CPI concluded
in January 1997. The NCI has the right to conduct as many additional clinical
trials as it would like and CPI is obligated to provide PREVATAC(TM) exisulind
for such studies. The Clinical Trials Agreement expires on July 1, 1999 unless
extended by both parties, and is subject to unilateral termination on sixty
days' notice by either party, subject in both cases to completion of clinical
trials that have been agreed to or are ongoing. CPI has retained all commercial
rights to PREVATAC(TM) exisulind, and the agreement with the NCI contains no
provisions for royalties or restrictions on CPI's ability to commercialize
PREVATAC(TM) exisulind.

         CPI has also entered into an amendment of the Clinical Trials Agreement
with the NCI to permit the NCI to conduct preclinical testing and, if agreed
with CPI, clinical testing of three additional CPI compounds. CPI believes that
continued collaboration with the NCI may advance the progress of both CPI and
the NCI in developing therapies to treat precancerous lesions in a variety of
tissues.

         In June 1991, CPI entered into a research and license agreement with
the University of Arizona (the "University"). Under the agreement, CPI has
agreed to attempt to commercialize at least one product while the University has
agreed to conduct a research program in support of CPI's efforts. The agreement,
as amended, provides for CPI to establish a budget for the research program with
the University on an annual basis and for CPI to be licensed under all patents
based on inventions developed by the University's employees in conjunction with
CPI. CPI has agreed to pay to the University a royalty based on sales of
products, if any, based on each such patent; this would apply to PREVATAC(TM)
exisulind in the event it is approved for sale by the FDA. The agreement expires
on June 26, 2000 unless extended by both parties, and is subject to termination
by CPI upon thirty days' notice.

         CPI contracts with university-based researchers and commercial vendors
throughout the U.S., Europe and Israel who furnish cell biology studies, in vivo
pharmacological studies, in vivo drug candidate screening, animal toxicological
studies, scale-up and synthesis of promising new compounds, conduct of 


                                       12
<PAGE>   15
clinical studies, laboratory analysis and/or other goods and services incident
to the development of the Company's business.

SCIENTIFIC ADVISORY BOARD

         CPI is assisted in its research and development activities by its
Scientific Advisory Board ("SAB") composed of physicians and scientists who
review CPI's research and development, participate in the design of clinical
trials, discuss technological advances relevant to CPI and its business and
otherwise assist CPI. The members of the SAB are appointed by CPI's management.
The SAB meets periodically and certain members meet in smaller groups or with
CPI individually as needed. Dr. Rifat Pamukcu, CPI's Chief Scientific Officer
and Senior Vice President, Research and Development, served as co-chair of CPI's
SAB prior to joining CPI in 1993, and continues to participate in all SAB
meetings. SAB members are compensated in cash and stock options for their
services to CPI. CPI also reimburses each member for expenses incurred when
traveling to and attending meetings. All SAB members have commitments or
consulting contracts with other organizations and companies, some of which are
competitors or potential competitors of CPI, that may limit their availability
to CPI. None of these individuals is expected to devote more than a small
portion of his time to CPI. The members of the SAB are listed below by area of
specialization.

                            SCIENTIFIC ADVISORY BOARD

<TABLE>
<CAPTION>
NAME                                 PROFESSIONAL AFFILIATION
----                                 ------------------------
<S>                                  <C>

CELLULAR & ANIMAL RESEARCH

Dennis Ahnen, M.D..................  Professor of Medicine, University of Colorado School of Medicine;
                                     Director of Cancer Prevention and Control, University of Colorado
                                     Cancer Center

David M. Livingston, M.D...........  Emil Frei Professor of Medicine, Harvard Medical School; Chief of
                                     the Division of Neoplastic Disease Mechanisms and Chairman of the
                                     Executive Committee for Research, Dana-Farber Cancer Institute

Alan C. Sartorelli, Ph.D...........  Alfred Gilman Professor of Pharmacology and Epidemiology, Yale 
                                     University School of Medicine; formerly Director of Yale
                                     Comprehensive Cancer Center

   
I. Bernard Weinstein, M.D..........  Frode Jensen Professor of Medicine, Genetics and
                                     Development and Public Health, Columbia University; Director
                                     Emeritus, Columbia University Comprehensive Cancer Center
    

CLINICAL & DRUG DEVELOPMENT

David S. Alberts, M.D..............  Associate Dean of Research, Director of Cancer
                                     Prevention and Control Program, and Professor of Medicine and
                                     Pharmacology, Arizona Cancer Center, University of Arizona

Randall W. Burt, M.D. (Chairman)...  Professor of Internal Medicine and Chief of Gastroenterology,
                                     University of Utah School of Medicine; formerly Chief of Medical
                                     Services, Veterans Administration Medical Center, Salt Lake City,
                                     Utah
</TABLE>


                                       13
<PAGE>   16
                            SCIENTIFIC ADVISORY BOARD
                                   (CONTINUED)

<TABLE>
<CAPTION>
NAME                                 PROFESSIONAL AFFILIATION
----                                 ------------------------
<S>                                  <C>
Daniel D. Von Hoff, M.D............  Director of the Institute for Drug Development, Cancer Therapy and 
                                     Research Center at the University of Texas Health Science Center

Louis M. Weiner, M.D...............  Chairman of the Department of Medical Oncology, Division of Medical 
                                     Science at Fox Chase Cancer Center; Professor in the Department of 
                                     Medicine, Temple University School of Medicine

INDUSTRY RESEARCH & DEVELOPMENT

Ira Ringler, Ph.D..................  Pharmaceutical industry consultant; formerly President of Takeda-Abbott 
                                     Pharmaceuticals, and Vice President, Pharmaceutical Research and 
                                     Development, Abbott Laboratories
</TABLE>

PATENTS, TRADEMARKS AND PROPRIETARY TECHNOLOGY

         CPI's success will depend, in part, on its ability to obtain patents,
operate without infringing the proprietary rights of others and maintain trade
secrets, both in the U.S. and other countries. Patent matters in the
pharmaceutical industry can be highly uncertain and involve complex legal and
factual questions. Accordingly, the validity, breadth, and enforceability of
CPI's patents and the existence of potentially blocking patent rights of others
cannot be predicted, either in the U.S. or in other countries.

         As of January 1999, CPI held title or exclusive licenses to two issued
U.S. patents and seven other pending U.S. patent applications relating to the
therapeutic uses of PREVATAC(TM) exisulind in the treatment of neoplasia,
precancerous lesions and/or other indications. The sulfone derivative of
sulindac, now named exisulind, was described in the scientific and patent
literature over 20 years ago and, as a result, CPI is unable to obtain a
composition of matter patent on PREVATAC(TM) exisulind. Thus, CPI's current
patent rights relating to PREVATAC(TM) exisulind are limited to a series of
patents and patent applications pertaining to various specific uses of
PREVATAC(TM) exisulind. CPI has also been issued or holds exclusive licenses to
14 foreign patents (including patents in various European countries, Australia,
Canada, Korea and Japan) relating to the use of PREVATAC(TM) exisulind in
pharmaceutical compositions for the treatment of neoplasia and/or precancerous
lesions. In Europe, CPI's patent rights relating to PREVATAC(TM) exisulind are
directed to the use of PREVATAC(TM) exisulind in the manufacture of
pharmaceutical compositions for the treatment of precancerous lesions. CPI also
holds title or exclusive licenses to six U.S. patents, three U.S. patent
applications which have been allowed, 60 other pending U.S. patent applications,
five issued foreign patents and 13 pending foreign applications on other
compounds, or therapeutic methods involving such compounds, for the treatment of
colonic polyps, precancerous lesions, and/or neoplasia. CPI also has filed three
U.S. and 14 foreign patent applications, and owns one issued U.S patent, on
methods for screening compounds for their usefulness in selectively inducing
apoptosis. CPI also has filed a U.S. application relating to diagnostic
methodologies. CPI intends to file additional applications, as appropriate, for
patents on new compounds, products, or processes discovered or developed through
application of CPI's technology.

         Beyond the patents granted to date, there can be no assurance that CPI
will discover or develop patentable products or processes, that patents will
issue from any of the currently pending patent applications, or that claims
granted on issued patents will be sufficient in their validity, breadth and
enforceability to protect CPI's technology or competitive commercial advantage.
Potential competitors or other researchers in the field may have filed patent
applications, been issued patents, published articles or otherwise created prior
art that could restrict or block CPI's efforts to obtain additional patents.
There can 


                                       14
<PAGE>   17
be no assurance that CPI's issued patents or pending patent applications, if
issued, will not be challenged, invalidated, circumvented or breached by others,
that judicial protection and enforcement will be available to CPI to counteract
such actions by others, or that the rights granted thereunder will provide
proprietary protection or competitive advantages to CPI. CPI's patent rights
also depend in part on its compliance with technology and patent licenses upon
which its patent rights are based and upon the validity of assignments of patent
rights from consultants and other inventors that are not or were not employed by
CPI.

         In addition, competitors may manufacture and sell CPI's potential
products in those foreign countries where CPI has not filed for patent
protection or where patent protection may be unavailable, not obtainable or
ultimately not enforceable. The ability of such competitors to sell such
products in the U.S. or in foreign countries where CPI has obtained patents is
usually governed by the patent laws of the countries in which the product is
sold. In addition, to the extent that clinical uses of PREVATAC(TM) exisulind
are discovered beyond those set forth in CPI's patent claims, CPI may not be
able to enforce its patent rights against companies marketing PREVATAC(TM)
exisulind for such other clinical uses.

         The success of CPI also will depend, in part, on CPI's not infringing
patents issued to others. Pharmaceutical companies, biotechnology companies,
universities, research institutions, and others may have filed patent
applications or have received, or may obtain, issued patents in the U.S. or
elsewhere relating to aspects of CPI's technology. It is uncertain whether the
issuance of any third-party patents will require CPI to alter its products or
processes, obtain licenses, or cease certain activities. Some third-party
applications or patents may conflict with CPI's issued patents or pending
applications. Such conflict could result in a significant reduction of the
coverage of CPI's issued or licensed patents. In addition, if patents are issued
to other companies which contain blocking, dominating or conflicting claims and
such claims are ultimately determined to be valid, CPI may be required to obtain
licenses to these patents or to develop or obtain alternative technology. If any
licenses are required, there can be no assurance that CPI will be able to obtain
any such licenses on commercially favorable terms, if at all, and if these
licenses are not obtained, CPI might be prevented from pursuing the development
of certain of its potential products. CPI's failure to obtain a license to any
technology that it may require to commercialize its products may have a material
adverse impact on CPI's business, financial condition and results of operations.

         Litigation, which could result in substantial costs to CPI, may also be
necessary to enforce any patents issued or licensed to CPI or to determine the
scope and validity of the proprietary rights of others. In this connection,
under the abbreviated new drug application ("ANDA") provisions of U.S. law,
after four years from the date marketing approval is granted to CPI by the FDA
for a patented drug, a generic drug company may submit an ANDA to the FDA to
obtain approval to market in the U.S. a generic version of the drug patented by
CPI. If approval is given to the generic drug company, CPI would be required to
promptly initiate patent litigation to prevent the marketing of such a generic
version prior to the normal expiration of the patent. There can be no assurance
that CPI's issued or licensed patents would be held valid by a court of
competent jurisdiction. In addition, if competitors of CPI file patent
applications in the U.S. that claim technology also claimed by CPI, CPI may have
to participate in interference proceedings to determine priority of invention.
These proceedings, if initiated by the U.S. Patent and Trademark Office, could
result in substantial cost to CPI, even if the eventual outcome is favorable to
CPI. An adverse outcome with respect to a third-party claim or in an
interference proceeding could subject CPI to significant liabilities, require
disputed rights to be licensed from third parties, or require CPI to cease using
such technology, any of which could have a material adverse effect on CPI's
business, financial condition and results of operations.

         CPI also relies on trade secrets to protect technology, especially
where patent protection is not believed to be appropriate or obtainable or where
patents have not been issued. CPI attempts to protect its proprietary technology
and processes, in part, by confidentiality agreements and assignment of
invention agreements with its employees and confidentiality agreements with its
consultants and certain contractors. There can be no assurance that these
agreements will not be breached, that CPI would have adequate remedies for any
breach, or that CPI's trade secrets will not otherwise become known or be
independently discovered by competitors. Such trade secrets or other
intellectual property of CPI, should they become known to its competitors, could
result in a material adverse effect on CPI's business, financial condition and
results of operations. To the extent that CPI or its consultants or research
collaborators use intellectual 


                                       15
<PAGE>   18
property owned by others in their work for CPI, disputes may also arise as to
the rights to related or resulting know-how and inventions.

         PREVATAC(TM) is CPI's proposed trademark for exisulind. CPI has filed
an intent to use trademark application for the mark with the U.S. Patent and
Trademark Office, and plans to perfect foreign trademark rights in the mark.
While CPI has searched for confusingly similar marks and believes that
PREVATAC(TM) is available for use on its product under prevailing standards of
trademark law, there can be no guarantee that that mark will not be challenged
by others, or that others have not perfected or attempted to perfect rights in a
confusingly similar mark. In the event of a successful challenge to CPI's
adoption and use of PREVATAC(TM), CPI could be forced to change its proposed
mark in one or more countries in the world.

         In January 1999, the labeling and nomenclature committee of the FDA
raised questions about CPI's proposed trademark PREVATAC for exisulind and found
that it would withhold permission for CPI to adopt that mark. CPI has filed a
request for reconsideration of that nomenclature committee finding to the FDA.
If CPI is not successful in such request, then CPI will be required to incur the
expense of developing and introducing a new trademark for exisulind.

COMPETITION

         The industry in which CPI competes is very competitive. It is
characterized by extensive research and development efforts and rapid
technological progress. New developments occur and are expected to continue to
occur at a rapid pace, and there can be no assurance that discoveries or
commercial developments by CPI's competitors will not render some or all of
CPI's potential products obsolete or non-competitive, which would have a
material adverse effect on CPI's business, financial condition and results of
operations. CPI's competitive position also depends on its ability to attract
and retain qualified scientific and other personnel, develop effective
proprietary products, implement development and marketing plans, obtain patent
protection and secure adequate capital resources.

         CPI faces competition in its specific areas of focus. In the fields of
cancer therapy and the prevention of precancerous and cancerous lesions, other
products and procedures are in use or in development that may compete directly
with the products that CPI is seeking to develop and market for cancer treatment
or cancer prevention. Surgery, radiation, chemotherapeutic agents and compounds
that interfere with hormone activities have been in use for years in the
treatment of cancer. Tamoxifen has been granted limited approval for use in the
prevention of breast cancer. CPI is aware of clinical trials in which a number
of pharmaceutical and nutritional agents are being examined for their potential
usefulness in the treatment of precancerous lesions and cancer. These include
studies of additional chemotherapeutic agents, monocloncal antibodies, hormone
blockers, thalidomide and other anti-angeogenesis agents in the treatment of
cancer; studies of NSAID-like compounds, cyclooxygenase inhibitors,
difluoromethylornithine ("DFMO") and natural nutrients in the treatment of APC
and sporadic colonic polyps; studies of retinoids and DFMO in the treatment of
cervical dysplasia; and studies of tamoxifen for the prevention of breast
cancer. Additional compounds being tested in various epithelial lesions include
compounds related to aspirin, various vitamins and nutritional supplements,
oltipraz, N-acetyl cysteine and compounds that interfere with hormone
activities. The studies are being conducted by pharmaceutical and biotechnology
companies, major academic institutions and government agencies. There are other
agents, including certain prescription drugs, that have been observed to have an
effect in the general area of cGMP PDE; although CPI is not aware that any third
party has demonstrated the preclinical utility of these compounds in the
treatment of precancerous or cancerous lesions, there can be no assurance that
such existing or new agents will not ultimately be found to be useful, and
therefore competitive with any future products of CPI.

         CPI expects near-term competition from fully integrated and more
established pharmaceutical and biotechnology companies. Most of these companies
have substantially greater financial, research and development, manufacturing
and marketing experience and resources than CPI and represent substantial
long-term competition for CPI. Such companies may succeed in discovering and
developing pharmaceutical products more rapidly than CPI or pharmaceutical
products that are safer, more effective or less costly than any that may be
developed by CPI. Such companies also may be more successful than CPI in
production and marketing. Smaller companies may also prove to be significant
competitors, particularly 


                                       16
<PAGE>   19
through collaborative arrangements with large pharmaceutical and established
biotechnology companies. Academic institutions, governmental agencies and other
public and private research organizations also conduct clinical trials, seek
patent protection and establish collaborative arrangements for the development
of oncology products.

         CPI will face competition based on product efficacy and safety, the
timing and scope of regulatory approvals, availability of supply, marketing and
sales capability, reimbursement coverage, price and patent position. CPI's
competitors may develop safer and more effective products or obtain patent
protection or intellectual property rights that limit CPI's ability to
commercialize products that may be developed or commercialize products earlier
than CPI. CPI's issued patents or pending patent applications, if issued, may be
challenged, invalidated or circumvented and the rights granted thereunder may
not provide proprietary protection or competitive advantage to CPI.

GOVERNMENT REGULATION

         CPI's activities are subject to extensive governmental regulation. In
particular, the research, design, testing, manufacturing, labeling, marketing,
distribution and advertising of products such as CPI's proposed products are
subject to extensive regulation by governmental regulatory authorities in the
U.S. and other countries. The drug development and approval process is generally
lengthy, expensive and subject to unanticipated delays. The FDA and comparable
agencies in foreign countries impose substantial requirements on the
introduction of new pharmaceutical products through lengthy and detailed
preclinical and clinical testing procedures, sampling activities and other
costly and time-consuming compliance procedures. A new drug may not be marketed
in the U.S. until it has undergone rigorous testing and has been approved by the
FDA. The drug may then be marketed only for the specific indications, uses,
formulation, dosage forms and strengths approved by the FDA. Similar
requirements are imposed by foreign regulators upon the marketing of a new drug
in their respective countries. Satisfaction of such regulatory requirements,
which includes demonstrating to the satisfaction of the FDA that the relevant
product is both safe and effective, typically takes several years or more
depending upon the type, complexity and novelty of the product and requires the
expenditure of substantial resources. Preclinical studies must be conducted in
conformance with the FDA's Good Laboratory Practice ("GLP") regulations. CPI's
compounds require extensive clinical trials and FDA review as new drugs.
Clinical trials are vigorously regulated and must meet requirements for FDA
review and oversight and requirements under Good Clinical Practice ("GCP")
guidelines. CPI may encounter problems in clinical trials which would cause CPI
or the FDA to delay or suspend clinical trials. Any such delay or suspension
could have a material adverse effect on CPI's business, financial condition and
results of operations. A discussion of the anticipated delay in
commercialization following preliminary evaluation of the Phase III study of
PREVATAC(TM) exisulind for APC appears above under "Products in Development".

         The steps required before a drug may be marketed in the U.S. include:
(i) preclinical laboratory and animal tests; (ii) submission to the FDA of an
application for an IND exemption, which must become effective before human
clinical trials may commence; (iii) human clinical trials to establish the
safety and efficacy of the drug; (iv) submission of a detailed NDA to the FDA;
and (v) FDA approval of the NDA. In addition to obtaining FDA approval for each
product, each domestic establishment where the drug is to be manufactured must
be registered with the FDA. Domestic manufacturing establishments must comply
with cGMP regulations and are subject to periodic inspections by the FDA.
Foreign manufacturing establishments manufacturing drugs intended for sale in
the U.S. also must comply with cGMP regulations and are subject to periodic
inspection by the FDA or by local authorities under agreement with the FDA.

         Preclinical tests include laboratory evaluation of product chemistry
and animal studies to assess the metabolic and pharmacologic activity and
potential safety and efficacy of the product. Preclinical tests must be
conducted by laboratories that comply with FDA regulations regarding GLP. The
results of preclinical tests are submitted to the FDA as part of an IND, which
must become effective before the sponsor may conduct clinical trials in human
subjects. Unless the FDA objects to an IND, the IND becomes effective 30 days
following its receipt by the FDA. There is no certainty that submission of an
IND will result in FDA authorization of the commencement of clinical trials. A
separate IND application may be required by the FDA, in its sole discretion, as
to each indication. The FDA has determined that all cancer 


                                       17
<PAGE>   20
prevention and therapeutic indications for which PREVATAC(TM) exisulind is or
will be tested are to be submitted under its current IND application filed in
December 1993.

         Clinical trials involve the administration of the investigational drug
to patients. Every clinical trial must be conducted under the review and
oversight of an institutional review board ("IRB") at each institution
participating in the trial. The IRB evaluates, among other things, ethical
factors, the safety of human subjects and the possible liability of the
institution. Clinical trials typically are conducted in three phases, which
generally are conducted sequentially, but which may overlap. Clinical trials
test for efficacy and safety, side effects, dosage, tolerance, metabolism and
clinical pharmacology. Phase I tests involve the initial introduction of the
drug to a small group of subjects to test for safety, dosage tolerance,
pharmacology and metabolism. Phase II trials involve 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. If a drug appears to be efficacious in Phase II evaluations,
larger-scale Phase III trials are undertaken to evaluate the safety and
effectiveness of the drug, usually, though not necessarily, in comparison with a
placebo or an existing treatment. There can be no assurance, however, that Phase
I, Phase II or Phase III testing will be completed successfully within any
specified time period, if at all; or that the designation of a trial by Phase
will not be changed by the Company or by the FDA; or that the FDA may not
increase, decrease or re-characterize the number and Phases of trials required
for approval. Furthermore, the FDA may suspend clinical trials at any time if it
decides that patients are being exposed to a significant health risk.

         The results of the preclinical studies and clinical trials are
submitted to the FDA as part of an NDA for approval of the marketing of the
drug. The NDA also includes information pertaining to the chemistry, formulation
and manufacture of the drug and each component of the final product, as well as
details relating to the sponsoring company. In prior years, the NDA review
process has taken from one to two years on average to complete, although reviews
of treatments for cancer and other life-threatening diseases may be accelerated.
The process may take substantially longer if the FDA has questions or concerns
about a product. In general, the FDA requires at least two adequate and
well-controlled clinical studies demonstrating efficacy in order to approve an
NDA. The FDA may, however, request additional information, such as long-term
toxicity studies or other studies relating to product safety, and may increase,
decrease or re-characterize the number and phases of trials required for
approval. Notwithstanding the submission of requested data, the FDA ultimately
may decide that the application does not satisfy its regulatory criteria for
approval. Finally, the FDA may require additional clinical tests following NDA
approval.

         CPI may not succeed in developing drugs that prove to be safe and
effective in treating or preventing cancer. The development of such drugs will
require the commitment of substantial resources to conduct the preclinical
development and clinical trials necessary to bring such compounds to market.
Drug research and development by its nature is uncertain. There is a risk of
delay or failure at any stage, and the time required and cost involved in
successfully accomplishing CPI's objectives cannot be predicted. Actual drug
research and development costs could exceed budgeted amounts, which could have a
material adverse effect on CPI's business, financial condition and results of
operations.

         CPI cannot predict when, if ever, it will submit an NDA for regulatory
review of one of its compounds currently under development. See the discussion
of PREVATAC(TM) exisulind and CP 461 above under "Products in Development." Once
CPI submits its potential products for review, there can be no assurance that
the FDA or other regulatory approvals for any pharmaceutical products developed
by CPI will be granted on a timely basis, if at all. The FDA and comparable
agencies in foreign countries impose substantial requirements on the
introduction of new pharmaceutical products through lengthy and detailed
preclinical and clinical testing procedures, sampling activities and other
costly and time-consuming compliance procedures. Clinical trials are vigorously
regulated and must meet requirements for FDA review and oversight and
requirements under GCP guidelines. A new drug may not be marketed in the U.S.
until it has been approved by the FDA. CPI may encounter delays or rejections,
and the FDA may make policy changes during the period of product development and
FDA regulatory review of each submitted NDA. A delay in obtaining or failure to
obtain such approvals would have a material adverse effect on CPI's business,
financial condition and results of operations. Even if regulatory approval is
obtained, it 


                                       18
<PAGE>   21
would be limited as to the indicated uses for which the product may be promoted
or marketed. A marketed product, its manufacturer and the facilities in which it
is manufactured are subject to continual review and periodic inspections. If
marketing approval is granted, CPI would be required to comply with FDA
requirements for manufacturing, labeling, advertising, record keeping and
reporting of adverse experiences and other information. In addition, CPI would
be required to comply with federal and state anti-kickback and other health care
fraud and abuse laws that pertain to the marketing of pharmaceuticals. Failure
to comply with regulatory requirements and other factors could subject CPI to
regulatory or judicial enforcement actions, including, but not limited to,
product recalls or seizures, injunctions, withdrawal of the product from the
market, civil penalties, criminal prosecution, refusals to approve new products
and withdrawal of existing approvals, as well as enhanced product liability
exposure, any of which could have a material adverse effect on CPI's business,
financial condition and results of operations. Sales of CPI's products outside
the U.S. will be subject to foreign regulatory requirements governing clinical
trials, marketing approval, manufacturing and pricing. Non-compliance with these
requirements could result in enforcement actions and penalties or could delay
introduction of CPI's products in certain countries.

         CPI's current clinical trial strategy for the development of drugs for
the prevention of precancerous lesions assumes that the FDA will accept
reduction in the formation of precancerous lesions as an endpoint for precancer
trials. To date, the FDA has not approved any chemoprevention compounds and
there can be no assurance that the FDA will approve such compounds in the
future. Should the FDA require CPI to demonstrate the efficacy of PREVATAC(TM)
exisulind in the reduction of certain cancers or in overall mortality rates
resulting from certain cancers, CPI's clinical trial strategy would be
materially and adversely affected, as significant additional time and funding
would be required to demonstrate such efficacy. There can be no assurance that
CPI will be able to successfully develop a safe and efficacious chemoprevention
product or that such product will be commercially viable or will achieve market
acceptance.

         In 1988 and again in 1992, the FDA issued regulations intended to
expedite the development, evaluation and marketing of new therapeutic products
to treat life-threatening and severely debilitating illnesses for which no
satisfactory alternative therapies exist. One program under these regulations
provides for early consultation between the sponsor and the FDA in the design of
both preclinical studies and clinical trials. Another program provides for
accelerated approval based on a surrogate endpoint. There can be no assurance,
however, that any future products CPI may develop will be eligible for
evaluation by the FDA under these regulations. In addition, there can be no
assurance that PREVATAC(TM) exisulind or any future products CPI may develop, if
eligible for these programs, will be approved for marketing sooner than would be
traditionally expected. Regulatory approval granted under these regulations may
be restricted by the FDA as necessary to ensure the safe use of the drug. In
addition, post-marketing clinical studies may be required. If PREVATAC(TM)
exisulind or any future products of CPI do not perform satisfactorily in such
post-marketing clinical studies, they would likely be required to be withdrawn
from the market.

         CPI has obtained Orphan Drug status for PREVATAC(TM) exisulind for the
treatment of APC. Although Orphan Drug status may provide an applicant exclusive
marketing rights in the U.S. for a designated indication for seven years
following marketing approval, in order to obtain such benefits, the applicant
must be the sponsor of the first NDA approved for that drug and indication.
Moreover, amendment of the Orphan Drug Act by the U.S. Congress and
reinterpretation by the FDA are frequently discussed. Therefore, there can be no
assurance as to the precise scope of protection that may be afforded by Orphan
Drug status in the future, or that the current level of exclusivity will remain
in effect.

         CPI has been granted Fast Track designation by the FDA for PREVATAC(TM)
exisulind for the reduction in development of new polyps in patients with APC.
The Fast Track Program is a new mechanism, introduced in the FDA Modernization
Act of 1997, for facilitating the development and expediting the approval of
drugs that demonstrate the potential to address unmet medical needs for serious
and life-threatening conditions. This mechanism builds upon existing FDA
programs for accelerated approval of such drugs. Among other things, the Fast
Track provisions provide for rolling review of the marketing application for the
Fast Track drug, so that portions of the application can be submitted and
reviewed by FDA before the complete application is submitted, which can help to
accelerate FDA review. Under Fast Track designation, CPI submitted to the FDA
two portions of its NDA filing with respect to 


                                       19
<PAGE>   22
PREVATAC(TM) for APC. The clinical portion has not been submitted; see the
discussion of the Phase III trial above under "Products in Development." If the
clinical portion of the NDA is submitted, there can be no assurance that
PREVATAC(TM) exisulind will be approved for marketing sooner than would be
traditionally expected. In addition, the FDA may require post-marketing studies
for a Fast Track drug. If such studies were required as a condition of approval
of PREVATAC(TM) exisulind and such studies thereafter showed that PREVATAC(TM)
exisulind is not safe or effective or failed to demonstrate any clinical
benefit, it is likely that PREVATAC(TM) exisulind would be required to be
withdrawn from the market for such indication.

         In most cases, pharmaceutical companies rely on patents to provide
market exclusivity for the periods covered by the patents. See "Patents,
Trademarks and Proprietary Technology" above. In the U.S., the Drug Price
Competition and Patent Term Restoration Act of 1984 (the "Hatch-Waxman Act")
permits an extension of patents in certain cases to compensate for patent time
expended during clinical development and FDA review of a drug. In addition, the
Hatch-Waxman Act establishes a period of market exclusivity, independent of any
patents, during which the FDA may not accept or approve abbreviated applications
for generic versions of the drug from other sponsors, although the FDA may
accept and approve subsequent long-form applications for the drug. The
applicable period of market exclusivity for a drug containing an active
ingredient not previously approved is five years. There is no assurance that all
or any of CPI's products, if approved, will receive market exclusivity under the
Hatch-Waxman Act. Failure to receive such exclusivity could have an adverse
effect on CPI's business, financial condition and results of operations.

         Among the requirements for product approval is the requirement that
prospective manufacturers conform to the FDA's cGMP standards, which also must
be observed at all times following approval. Accordingly, manufacturers must
continue to expend time, money and effort in production, record keeping and
quality control to ensure compliance with cGMP standards. Failure to so comply
subjects the manufacturer to possible FDA action, such as the suspension of
manufacturing or seizure of the product. The FDA may also request a voluntary
recall of a product.

         Health care reform legislation, if enacted, could result in significant
change in the financing and regulation of the health care business. In addition,
legislation affecting coverage and reimbursement under Medicare, Medicaid and
other government medical assistance programs has been enacted from time to time.
CPI is unable to predict whether such legislation will be enacted in the future
or, if enacted, the effect of such legislation on the future operation of CPI's
business. Changes adversely affecting drug pricing, drug reimbursement and
prescription benefits, among other changes, could have a materially adverse
effect on CPI's business, financial condition and results of operations.

MANUFACTURING

         CPI currently has no manufacturing facilities for clinical or
commercial production of any of its compounds under development. CPI is
currently relying on third-party manufacturers to produce its compounds for
research and clinical purposes. Therefore, CPI will need to develop its own
facilities or contract with third parties for the manufacture of products, if
any, that it may develop for its own account or in connection with collaborative
arrangements in which it has retained manufacturing rights. CPI is working with
manufacturers of both bulk drug and final pharmaceutical dosage forms.

MARKETING AND SALES

         CPI has to date retained all rights to PREVATAC(TM) exisulind and its
other compounds and plans to establish its own sales, marketing and distribution
organization either with internal resources or contracted third-party providers.
CPI plans to promote PREVATAC(TM) exisulind, if approved for sale for these
conditions, primarily to the gastroenterologists and other physicians who manage
patients with APC, sporadic adenomatous colonic polyps and Barrett's Esophagus.
These initial markets are treated by approximately 10,500 physicians, a
relatively small target audience. If CPI receives additional FDA approvals for
PREVATAC(TM) exisulind, CPI may expand its sale and marketing team to reach
other targeted 


                                       20
<PAGE>   23
groups of physicians. Target groups would include the approximately 10,000
urologists who manage most prostate cancer patients, the approximately 8,400
pulmonary specialists and thoracic surgeons who are primarily responsible for
performing bronchoscopies and managing treatment of individuals with bronchial
dysplasia and the approximately 5,500 oncologists who manage cancer therapy
patients.

         Certain indications, based on their treatment by a large number of
physicians, require an extensive sales force to sufficiently reach the
appropriate physician groups. Cervical dysplasia, for example, is treated by
approximately 36,000 gynecologists. To reach these more extensive physician
groups, CPI may, if appropriate, enter into co-marketing agreements with
pharmaceutical or biotechnology companies.

         CPI anticipates marketing its products in Europe by entering into
strategic alliance agreements with established sales organizations located in
such markets. In Japan and other Pacific Rim countries, CPI is seeking marketing
partners to assist in local clinical trials, regulatory filings and marketing,
sales and distribution. While seeking international collaborations, CPI will
continue to pursue the clinical development and the regulatory approval of
PREVATAC(TM) exisulind in major international markets. See "Risk Factors - Risk
Factors Related to the Business and Operations of CPI -- Absence of Sales and
Marketing Experience; Dependence on Third Parties".

EMPLOYEES

         As of January 31, 1999, CPI employed 58 persons full-time.


EXECUTIVE OFFICERS AND KEY EMPLOYEES

ROBERT J. TOWARNICKI, 47, has served as Chief Executive Officer and a Director
of CPI since October 1996 and President of CPI since January 1998. Prior to
joining CPI, from 1992 to 1996, he served as President, Chief Operating Officer,
a director and most recently as Executive Vice President of Integra LifeSciences
Corporation, which is the publicly held parent firm for a group of biotechnology
and medical device companies including Collatech, Inc., ABS LifeSciences Inc.,
Telios Pharmaceuticals, Inc. and Vitaphore Corporation. In addition, from 1991
to 1992, he served as Founder, President and Chief Executive Officer of MediRel,
Inc. From 1989 to 1991, he was General Manager of Focus/MRL, Inc.; from 1985 to
1989, he was Vice President of Development and Operations for Collagen
Corporation and from 1974 to 1985, he held a variety of operations management
positions at Pfizer, Inc. and Merck & Co., Inc. Mr. Towarnicki was a Ph.D.
candidate in Pharmaceutical Chemistry at Temple University School of Pharmacy
and received his M.S. and B.S. degrees from Villanova University.

BRIAN J. HAYDEN, 47, has served as Vice President, Finance and Chief Financial
Officer of CPI since November 1997 and as Treasurer since June 1998. Prior to
joining CPI, during 1996 and 1997, he served as Vice President of Finance and
Administration for NeoStrata, Inc., a dermatology company and Vice President and
Chief Financial Officer of Micrus Corporation, a medical device company. From
1992 to 1996, he served as Vice President, Finance, Chief Financial Officer and
Treasurer of Biomatrix, Inc., a public medical device company. From 1988 to
1992, he served as Vice President, Chief Financial Officer, Treasurer and
Secretary of Alteon Inc., a public biopharmaceutical company. Mr. Hayden served
as Vice President, Finance and Administration for Healthways Systems, Inc., a
managed care organization, from 1985 to 1988. From 1976 to 1985, he served in
various auditing, financial analysis and senior financial management positions
with Hoffmann-La Roche, Inc. He served as a Senior Auditor from 1973 to 1976
with Coopers and Lybrand LLP. Mr. Hayden received a B.B.A. in Accounting from
Loyola University of Chicago and has completed graduate courses at Seton Hall
University.

RIFAT PAMUKCU, M.D., 41, is CPI's Chief Scientific Officer and Senior Vice
President Research and Development. Dr. Pamukcu is a co-founder of CPI. Prior to
joining CPI full time in 1993, from 1989 to March 1993, he was Assistant
Professor of Medicine at the University of Cincinnati and co-chair of CPI's SAB.
He continued as an Adjunct Assistant Professor of Medicine at the University of
Cincinnati from 1993 to 1995. He was a postdoctoral fellow from 1986 to 1989 in
the Division of Gastroenterology at the 


                                       21
<PAGE>   24
University of Chicago. Dr. Pamukcu received a B.A. in Biology from Johns Hopkins
University in 1979 and an M.D. degree from the University of Wisconsin School of
Medicine in 1983.

RICHARD H. TROY, 61, has served as Senior Vice President, Corporate Development
of CPI since November 1997, Vice President , Finance, Law and Administration
from January 1993 until November 1997, and General Counsel, Secretary and a
Director since December 1992. He has been an advisor to CPI since its inception,
and he is a Director and President of FGN, Inc., the predecessor partnership's
first general partner and a principal stockholder of CPI. Prior to joining CPI,
from 1990 to 1992, he served as Vice President and Associate General Counsel of
UST, Inc. Prior to that, from 1973 to 1990, he worked at Combustion Engineering,
Inc., most recently as Vice President and Deputy General Counsel, and from 1964
to 1973, he practiced law with the firm of Shearman & Sterling in New York City.
Mr. Troy received a B.A. in Philosophy from Georgetown University in 1959,
studied at the Ludwig-Maximilians-Universitat in Munich in 1959-60, and received
a LL.B. degree from Harvard Law School in 1963.

HECTOR ALILA, D.V.M., Ph.D., 46, has served as Vice President of Product
Development of CPI since February 1998. Prior to joining the Company, he was
Director of Pharmacology/Biology at GeneMedicine, Inc. from 1994 to 1998. He
also headed their Toxicology/Pharmacokinetic Studies and Growth Factors Program.
He was Project Leader and Senior Investigator at SmithKline Beecham from 1988 to
1994 and was Senior Research Associate in the Department of Physiology at
Cornell University from 1986 to 1988. Dr. Alila was Lecturer/Senior Research
Scientist at the University of Nairobi and Kenya Medical Research Institute from
1984 to 1986. Dr. Alila received his Bachelor of Veterinary Medicine from the
University of Nairobi in 1978. He received his Ph.D. in Physiology/Endocrinology
from Cornell University in 1984.

LLOYD G. GLENN, 43, has served as Vice President, Marketing of CPI since June
1998. Prior to joining CPI, from 1995 to 1998, he served as Vice President of
Marketing for Athena Neurosciences, Inc., the Neurological Division of Elan.
From 1983 to 1994, he served in a series of sales management positions,
ultimately serving as Senior Product Manager for the Pharmaceutical Division of
Allergan, Inc. His additional past experience includes positions at Block Drug,
from 1982 to 1983, and Airwork, a subsidiary of Purex, Inc. from 1981 to 1982.
Mr. Glenn received his B.S. degree in marketing from Brigham Young University.

KERSTIN B. MENANDER, M.D., PH.D., 61, has served as Vice President, Medical and
Regulatory Affairs of CPI since January 1997. Prior to joining CPI, from 1989 to
1997 she was President of US 3D Development, Inc. From 1992 to 1994 she was also
a corporate officer and Vice President, Medical Affairs of Curative
Technologies, Inc. Between 1986 and 1989 she served as Vice President, Medical
and Regulatory Affairs and a corporate officer of Collagen Corporation. From
1973 to 1986 she held a variety of clinical and regulatory positions at
companies such as Syntex Corporation and Abbott Laboratories. Dr. Menander
received her M.D. and Ph.D. from the University of Lund, Sweden, where she also
did research and taught as Associate Professor of Histology of the Medical
Faculty.

ROBERT W. STEVENSON, J.D. 44, has served as CPI's Vice President, Intellectual
Property of CPI since November 1997. Prior to joining the Company, he was an
attorney at Brinks Hofer Gilson & Lione, where he served as a partner from 1992
to 1997 and as counsel from 1988 until 1992. He served as CPI's outside patent
counsel since its inception. In addition, he was an Adjunct Professor of Patent
Law at DePaul University from 1992-1996. Before joining Brinks Hofer Gilson &
Lione, he was a senior attorney at Abbott Laboratories, where he handled a
variety of patent matters involving pharmaceuticals and biotechnology. Mr.
Stevenson received his B.S.E. from Penn State University in 1977, his M.S.E.
from the University of Michigan in 1979, and his J.D. from Wayne State
University in 1982.

W. JOSEPH THOMPSON, Ph.D., 55, has served as Vice President, Research of CPI
since June 1998. He joined the Company from the University of South Alabama
College of Medicine, where he was Professor of Pharmacology in the Department of
Pharmacology from 1983 to 1998. Prior to that time, he was employed from 1973 to
1983 at the University of Texas Medical School at Houston, where he ultimately
held the title of Professor of Pharmacology. Dr. Thompson is a member of the
editorial board of the Journal of Second Messengers and Phosphoprotein Research
and is the author of over 268 scientific 


                                       22
<PAGE>   25
publications. He received his Ph.D. degree in biochemistry from the University
of Southern California, and has a B.A. degree from Depauw University in Indiana.

RISK FACTORS

         The following risk factors relate to the business of the Company and
qualify the statements made in this report about the business of the Company.
These factors, among others, could cause actual results to differ materially
from those contained in forward-looking statements made in this report and/or
presented elsewhere by management from time to time. The subheadings below
identify the risks discussed but cannot do so completely. Each subsection may
relate to more than one aspect of the Company's business. Accordingly, each risk
factor should be considered carefully in evaluating the business of the Company,
any investment in the Company and the descriptions of the Company contained in
this report. To avoid unnecessary duplication, discussion below refers back to
discussion of similar subject matter elsewhere in this Item 1. Please note below
and elsewhere in Items 1 and 3 of this report the discussion of the Company's
February 1, 1999 announcement concerning anticipated delay in commercialization
arising from preliminary analysis of the phase III trial of PREVATAC(TM) 
exisulind and the several class action lawsuits which were filed after that 
announcement. See, also, the cautionary language contained at the beginning of 
this Item 1. Business.

         History of Operating Losses; Accumulated Deficit; Expected Future
Losses. CPI and its predecessor have experienced significant operating losses
since inception in 1990. CPI has not received any revenue from the sale of
products and no product candidate of CPI has been approved for marketing. As of
December 31, 1998, CPI had an accumulated deficit of approximately $ 45.3
million. CPI expects to incur additional operating losses over the next several
years and expects cumulative losses to increase substantially as CPI's research
and development efforts and preclinical and clinical testing expand. CPI's
ability to achieve profitability is dependent on its ability, alone or with
others, to complete the development of its proposed products successfully,
obtain the required regulatory approvals, manufacture and market its proposed
products successfully or have such products manufactured and marketed by others
and gain market acceptance for such products. CPI may not achieve profitability.
See "CPI Management's Discussion and Analysis of Financial Condition and Results
of Operations" in Item 7 of this report.

         Stock Volatility; Class Action Litigation. The market price of
development stage companies is typically volatile. When there is a sharp drop in
the stock price, stockholder class actions may be filed against the particular
company. CPI is a development stage company. Its stock price has been volatile.
The stock price dropped substantially after the Company announced on February 1,
1999 that it anticipated a delay in commercialization following preliminary
evaluation of unblinded data from its Phase III clinical trial of PREVATAC(TM)
exisulind for APC, which preliminary evaluation suggested that the study had not
achieved statistical significance. The Company has not completed its analysis of
the Phase III trial and will not be able to announce the results of this trial
until the second quarter of 1999. As of March 26, 1999, five stockholder class
actions had been filed against the Company and certain of its officers. See the
discussion under "Product in Development" above, "Dependence on PREVATAC(TM)
exisulind" below, and "Absence of Prior Trading Market; Potential Volatility of
Stock Price; No Dividends" below, and Item 3 "Legal Proceedings" of this report.

         Early Stage of Development; Absence of Developed Products; Uncertainty
of Clinical Trials. CPI is at an early stage of development and must be
evaluated in light of the uncertainties and complications present in a
development stage company. CPI has no products approved for sale in any country.
CPI has only one product candidate which has been in clinical trials for an
appreciable of length of time, PREVATAC(TM) exisulind. CPI has completed only
limited human clinical trials designed to demonstrate the safety and efficacy of
PREVATAC(TM) exisulind and has not commenced such trials for any other compounds
with the exception of Phase I studies of a new compound, CP 461, which are
expected to commence in the second quarter of 1999. CPI has not generated any
revenue from product sales to date and no product candidate of CPI has been
approved for marketing. Accordingly, CPI's income has been limited to interest
income from investments and CPI's primary source of capital has been the sale of
equity securities.


                                       23
<PAGE>   26
         Before obtaining regulatory approval for the commercial sale of any of
its product candidates, CPI must demonstrate through preclinical and clinical
trials that the product is safe and effective for use in each target indication.
The results from preclinical and early clinical trials may not be predictive of
results that will be obtained in later stage clinical trials. The clinical
trials of CPI's product candidates may not demonstrate sufficient safety and
efficacy to obtain the requisite regulatory approvals and result in marketable
products. Clinical trials are often conducted with patients who are critically
ill. During the course of treatment these patients may die or suffer other
adverse medical events for reasons that may not be related to the pharmaceutical
agent being tested, but which can nevertheless affect clinical trial results. A
number of companies in the pharmaceutical and biotechnology industries have
suffered significant setbacks in advanced clinical trials, even after achieving
promising results in earlier trials.

         The completion of clinical trials of CPI's product candidates could be
interrupted by many factors. Delays and terminations may occur. One relevant
factor is the rate of enrollment of patients, which generally varies throughout
the course of a clinical trial and which depends on the size of the patient
population, the number of clinical trial sites, the proximity of the patients to
clinical trial sites, the eligibility criteria for the clinical trial and the
existence of competitive clinical trials. CPI cannot control the rate at which
patients present themselves for enrollment. The rate of patient enrollment may
not be consistent with CPI's expectations or be sufficient to enable clinical
trials of CPI's product candidates to be completed in a timely manner. See the
discussion of CPI's clinical trials above under "Products in Development." CPI
has limited experience managing clinical trials and any delays or terminations
of such trials could have a material adverse effect on CPI's business, financial
condition and results of operations.

         Trials to date have involved only a limited number of patients. CPI may
not be able to submit an NDA to the FDA or the foreign equivalent with respect
to PREVATAC(TM) exisulind for APC or any other indication. In addition, results
obtained in clinical trials for the treatment of APC may not be predictive of
results of clinical trials for other indications. If CPI's product candidates
are not shown to be safe and effective in clinical trials for one or more
indications, there would be a material adverse effect on CPI's business,
financial condition and results of operations.

         CPI faces intense competition. In the fields of cancer therapy and the
prevention of precancerous and cancerous lesions, other products are being
developed that may compete directly with the products that CPI is seeking to
develop and market. CPI is aware of clinical trials in which a number of
pharmaceutical and nutritional agents are being examined for their potential
usefulness in the treatment of precancerous lesions and cancer. The studies are
being conducted by pharmaceutical and biotechnology companies, major academic
institutions and government agencies. Such existing or new agents may ultimately
be found to be useful, and therefore competitive with, any future products of
CPI. See the discussion above under "Competition."

         CPI may not be able to submit an IND or foreign equivalents with
respect to any new chemical entities or follow-on compounds (other than that
filed in December 1998 with respect to CP 461). CPI may not be permitted to
undertake human clinical testing of such additional compounds, and, if human
clinical testing is permitted, such compounds may not prove to be safe and
effective. CPI's compounds may prove to have undesirable and unintended side
effects or other characteristics that may prevent or limit their commercial use.
Products, if any, resulting from CPI's research and development programs may not
be commercially available for a number of years even if they are successfully
developed and proven to be safe and effective. Thus, there can be no assurance
that any of CPI's product development efforts will be successfully completed,
that regulatory approvals will be obtained or will be as broad as sought, that
CPI's products will be capable of being produced in commercial quantities at a
reasonable cost or that any products, if introduced, will achieve market
acceptance. The failure of CPI to complete clinical trials, obtain regulatory
approval or successfully market its products, if approved, would have a material
adverse effect on CPI's business, financial condition and results of operations.
See "Products in Development" and "Government Regulation" above.

         Dependence on PREVATAC(TM) exisulind. Through the first quarter of
1999, CPI has had only one compound, PREVATAC(TM) exisulind, in clinical trials,
and does not expect to have an additional compound 


                                       24
<PAGE>   27
(other than CP 461) in clinical trials until it is able to file an additional
IND. PREVATAC(TM) exisulind has not been approved for marketing by the FDA for
any indication, and trials to date have involved only a limited number of
patients. There can be no assurance that marketing approval for
PREVATAC(TM)exisulind will be obtained.

        In January of 1999, CPI completed a double-blind, placebo-controlled
pivotal Phase III study of PREVATAC(TM) exisulind in APC. Preliminary
evaluation of the unblinded data from this trial suggested that the study did
not achieve statistical significance. On February 1, 1999, the Company
announced that it  anticipated a delay in the filing of an NDA with the FDA for
APC and that the  Company would be evaluating the data in a process which was
expected to continue  for some weeks. In the release the Company also stated
that the preliminary  evaluation appeared inconsistent with data from the
previous Phase I/II and extension studies as well as from studies in animal
models and cell culture systems. The preliminary evaluation was an adverse
development. Following its announcement by the Company, the market price of the
Company's common stock declined substantially. As of March 26, 1999, the
Company had not completed its evaluation of the data from the Phase III trial
and had not formulated its further plans with respect to the filing of an NDA
for APC.

          If approved for marketing, PREVATAC(TM) exisulind may not gain market
acceptance. In addition, competition to PREVATAC(TM) exisulind may develop from
other new or existing products. The failure of PREVATAC(TM) exisulind to be
approved for marketing or to gain market acceptance would have a material
adverse effect on CPI's business, financial condition and results of operations.

         The number of APC patients in the U.S. is limited and may be as few as
8,000 to 36,000. In order to increase the potential applications for which
PREVATAC(TM) exisulind may be used, CPI must successfully complete lengthy
clinical trials and thereafter receive marketing clearance from the FDA for each
additional indication. CPI may not successfully complete these clinical trials
and receive appropriate regulatory clearance on a timely basis, if at all. The
inability to achieve marketing clearance of PREVATAC(TM) exisulind for at least
one indication in addition to APC would be expected to materially limit the
commercial potential of PREVATAC(TM) exisulind and thereby have a materially
limiting and adverse effect upon CPI's business, financial condition and results
of operations. The Orphan Drug and Fast Track designations may not provide any
meaningful competitive advantage to CPI. See "Government Regulation" above.

         Technological Uncertainty; Regulatory Uncertainty. To date, the FDA has
not approved any drug for the prevention of precancerous lesions or cancer
(other than a limited approval of tamoxifen for prevention of breast cancer).
CPI may not be able to develop successfully such a chemoprevention drug; and if
it can, CPI may not be able to develop such a drug within CPI's proposed
timelines. Even is such a drug is approved, such a drug may not be commercially
viable and may not achieve market acceptance. CPI's area of focus, oncology in
general and chemoprevention in particular, is not thoroughly understood. The
products CPI is seeking to develop may not prove to be safe and effective in
preventing or treating precancerous lesions or cancer.

         CPI believes that PREVATAC(TM) exisulind and its other compounds
selectively induce apoptosis through a novel mechanism. Additional research by
CPI or others may cause CPI to revise or abandon this approach, adversely
affecting CPI's ability to develop products on a timely basis, if at all. The
use of CPI's technology may not lead to the development and approval of
commercial pharmaceutical products that are safe and efficacious. CPI's
competitors may develop safer and more effective products, may obtain patent
protection or intellectual property rights that limit CPI's ability to
commercialize products, and may commercialize products earlier than CPI. See
"CPI Technology" above.

         Future Capital Needs; Uncertainty of Additional Funding. CPI will have
continuing needs for additional capital. Development of CPI's initial product
candidate, PREVATAC(TM) exisulind, and additional compounds will require
substantial additional funds to conduct research, development and clinical
trials necessary to bring such products to market and to establish
manufacturing, marketing and distribution capabilities.


                                       25
<PAGE>   28
         The extent of CPI's future capital requirements will depend on many
factors, including, among others: the length of the current delay in the
commercialization plans for PREVATAC(TM) exisulind, and the reevaluation of
other programs in light of this delay; scientific progress in research and
development programs; progress with preclinical and clinical trials; progress in
obtaining regulatory approvals; the costs involved in preparing, filing,
prosecuting, maintaining and enforcing patent claims; competing technological
efforts and market developments; changes in CPI's existing research
relationships; changes in the programs of clinical development of one or more
compounds; the ability of CPI to establish sales and marketing capabilities; the
extent of competition; and the ability of CPI to establish collaborative
arrangements to the extent necessary.

         The need for additional capital may arise from additional factors.
There is always a risk of delay or failure at any stage of developing a product
candidate. Additional compounds may be introduced into clinical testing. The
time required and costs involved in successfully accomplishing CPI's objectives
cannot be predicted. Actual drug research and development costs could
substantially exceed budgeted amounts. Revenue and expense forecasts, if made by
CPI, may not prove to be accurate. Any of the foregoing, singly or in
combination, could have a material adverse effect on CPI's business, financial
condition or results of operations and could increase CPI's need for additional
capital.

         To the extent necessary, CPI will need to seek additional funding
through public or private equity or debt financings, collaborative
relationships, capital lease transactions or other available financing
transactions. However, additional financing may not be available on acceptable
terms, if at all; and such financings could be dilutive to stockholders.
Moreover, in the event that additional funds are obtained through arrangements
with collaborative partners, such arrangements may require CPI to relinquish
rights to certain of its technologies, product candidates or products that CPI
would otherwise seek to develop or commercialize itself. If adequate funds are
not available, CPI may be required to delay, reduce the scope of or eliminate
one or more of its research or development programs. The failure of CPI to
obtain adequate financing when needed and on acceptable terms would have a
material adverse effect on CPI's business, financial condition and results of
operations. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations" in Item 7.

         Uncertainty of Protection of Patents, Trademarks and Proprietary
Rights. Patents are important to CPI and to its competitors. CPI's success will
depend, in part, on its ability to obtain patents, establish and maintain
trademarks, operate without infringing the proprietary rights of others and
maintain trade secrets, both in the U.S. and other countries. Patent matters in
the pharmaceutical industry can be highly uncertain and involve complex legal
and factual questions. Accordingly, the validity, breadth, and enforceability of
CPI's patents and the existence of potentially blocking patent rights of others
cannot be predicted, either in the U.S. or in other countries. See "Patents,
Trademarks and Proprietary Technology" above.

         Intense Competition; Rapid Technological Change. The industry in which
CPI competes is very competitive. It is characterized by extensive research and
development efforts and rapid technological progress. New developments occur and
are expected to continue to occur at a rapid pace. Discoveries and commercial
developments by CPI's competitors may render some or all of CPI's potential
products obsolete or non-competitive, which would have a material adverse effect
on CPI's business, financial condition and results of operations. CPI's
competitive position also depends on its ability to attract and retain qualified
scientific and other personnel, develop effective proprietary products,
implement development and marketing plans, obtain patent protection and secure
adequate capital resources. See "Competition" above.

         Dependence on Third-Party Relationships. CPI depends on third parties.
In particular, CPI's development and clinical testing efforts are dependent on
third-party contractors, such as contractors for animal toxicology studies,
contract research organizations and clinical trial sites. Loss, failure or delay
in respect of any material portion of such contracting activity could delay
CPI's development efforts and could have a material adverse effect on CPI's
business, financial condition and results of operations.

         CPI's strategy for commercialization of its proposed products for
certain indications and markets includes collaborating with corporate partners
and others, and, to the extent that such corporate partnerships 


                                       26
<PAGE>   29
may be entered into, is dependent upon the subsequent success of these outside
parties in performing their responsibilities. CPI currently does not have any
collaborations for the commercialization of products. CPI may not be able to
negotiate any collaborative arrangements in the future on acceptable terms, if
at all; and, if negotiated, such collaborative arrangements may not be
maintained or may not prove to be successful. To the extent that such
arrangements are negotiated, the amount and timing of resources to be devoted to
these activities are not within the complete control of CPI. Partners may not
perform their obligations as expected. CPI may not derive any revenue from such
arrangements. Future collaborators may pursue their existing or alternative
technologies or product candidates in preference to those being developed in
collaboration with CPI. In addition, there can be no assurance that CPI's future
collaborators will pay license fees to CPI, that they will develop and market
any products under the agreements or that they will commit to fund product
development costs. To the extent that CPI chooses not to enter into
collaborative relationships, or is unable to establish such arrangements, CPI
would be required to continue to undertake research, development and marketing
of its proposed products at its own expense. In addition, CPI may encounter
significant delays in introducing its proposed products into certain markets or
find that the development, manufacture or sale of its proposed products in such
markets is adversely affected by the absence of such collaborative agreements.
See "Products in Development", "Manufacturing", "Marketing and Sales" and
"National Cancer Institute and Other Third-Party Arrangements" above.

         Extensive Government Regulation; No Assurance of Necessary FDA and
Other Regulatory Approvals. CPI's activities are subject to extensive
governmental regulation. In particular, the research, design, testing,
manufacturing, labeling, marketing, distribution and advertising of
pharmaceutical products such as CPI's proposed products are subject to extensive
regulation by governmental regulatory authorities in the U.S. and other
countries. The drug development and approval process is generally lengthy,
expensive and subject to unanticipated delays. Data obtained from preclinical
and clinical testing are subject to varying interpretations that could delay,
limit or prevent FDA approval. In addition, delays or rejections may be
encountered based upon changes in FDA policy for drug approval during the period
of development and FDA regulatory review of each submitted NDA. Satisfaction of
such regulatory requirements, which includes demonstrating to the satisfaction
of the FDA that the relevant product is both safe and effective, typically takes
several years or more depending upon the type, complexity and novelty of the
product and requires the expenditure of substantial resources. CPI may encounter
problems in clinical trials which would cause CPI or the FDA to delay or suspend
clinical trials; and CPI may encounter delays in the FDA approval process. Any
such delay or suspension could have a material adverse effect on CPI's business,
financial condition and results of operations. On February 1, 1999, the Company
announced that it anticipated a delay in light of preliminary evaluation data
from the phase III trial of PREVATAC(TM) exisulind for APC. See "Governmental
Regulations" and "Products in Development" above in this Item 1 and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in Item 7.

         CPI's may not successfully complete clinical trials for compounds
currently under development within any specified time period, if at all.
Further, such testing may not show PREVATAC(TM) exisulind or any other product
to be safe or effective. CPI may encounter problems in clinical trials that will
cause CPI to delay or suspend clinical trials. See "Products in Development"
above.

         CPI's current clinical trial strategy for the development of drugs for
the prevention of precancerous lesions assumes that the FDA will accept
reduction in the formation of precancerous lesions as an endpoint for precancer
trials. To date, the FDA has not approved any chemoprevention compounds (other
than a limited approval of tamoxifen for prevention of breast cancer) and there
can be no assurance that the FDA will approve such compounds in the future.
Should the FDA require CPI to demonstrate the efficacy of PREVATAC(TM) exisulind
in the reduction of certain cancers or in overall mortality rates resulting from
certain cancers, CPI's clinical trial strategy would be materially and adversely
affected, as significant additional time and funding would be required to
demonstrate such efficacy. CPI may not be able to successfully develop a safe
and effective chemoprevention product, and, if developed, such product may not
be commercially viable or may not achieve market acceptance.

         Even after such time has been expended and expenses incurred by CPI in
product development, CPI may fail to obtain regulatory approval for any
therapeutic product. Further, even if such regulatory approval is obtained, CPI,
its products, its contract manufacturers and its commercial collaborators are


                                       27
<PAGE>   30
subject to continual regulatory review in both the U.S. and other countries, and
later discovery of previously unknown problems with regard to such a product,
distributor or manufacturer may result in restrictions on such product or
manufacturer, including withdrawal of the product from the market and
disqualification or decertification of the distributor or manufacturer.

         Potential Limitations on Third-Party Reimbursement; Health Care Reform.
In both U.S. and foreign markets, sales of CPI's proposed products will depend
in part on the availability of reimbursement from third-party payors such as
government health administration authorities, private health insurers and other
organizations. The levels of revenues and profitability of pharmaceutical
companies may be affected by the continuing efforts of governmental and
third-party payors to contain or reduce the costs of health care. CPI cannot
predict the effect that private sector or governmental health care reforms may
have on its business, and there can be no assurance that any such reforms will
not have a material adverse effect on CPI's business, financial condition and
results of operations. In addition, in both the U.S. and elsewhere, sales of
prescription drugs are dependent in part on the availability of reimbursement to
the consumer from third-party payors, such as government and private insurance
plans. Third-party payors are increasingly challenging the price and
cost-effectiveness of medical products and services. Significant uncertainty
exists as to the reimbursement status of newly approved health care products.
There can be no assurance that CPI's proposed products will be considered
cost-effective or that adequate third-party reimbursement will be available to
enable CPI to maintain price levels sufficient to realize an appropriate return
on its investment in product development. Legislation and regulations affecting
the pricing of pharmaceuticals may change before any of CPI's proposed products
are approved for marketing. Adoption of such legislation could further limit
reimbursement for medical products and services. As a result, CPI may elect not
to market future products in certain markets.

         Lack of Manufacturing Experience; Reliance on Contract Manufacturers
and Suppliers. CPI does not have facilities to manufacture and produce its
compounds for preclinical, clinical or commercial purposes. CPI's product
candidates have never been manufactured for commercial purposes and there can be
no assurance that such products can be manufactured at a cost or in quantities
necessary to make them commercially viable, although CPI's lead compound,
PREVATAC(TM) exisulind, has been manufactured by CPI's contractors at commercial
scale. If CPI is unable to manufacture or contract for a sufficient supply of
its compounds on acceptable terms, or if it should encounter delays or
difficulties in its relationships with manufacturers, CPI's preclinical and
human clinical testing schedule would be delayed, resulting in delay of the
submission of products for regulatory approval or delay of the market
introduction and subsequent sales of such products, which would have a material
adverse effect on CPI's business, financial condition and results of operations.
Furthermore, CPI or contract manufacturers must supply all necessary
documentation in support of CPI's NDA on a timely basis and must adhere to GLP 
and current Good Manufacturing Practice ("GMP") regulations enforced by the FDA
through its facilities inspection program. If these facilities cannot pass a
pre-approval plant inspection, the FDA approval of the products will not be
granted.

         CPI currently does not have long-term supply agreements. There can be
no assurance that CPI's current suppliers will continue to make available to CPI
the required quantities of PREVATAC(TM) exisulind on reasonable terms, if at
all. If CPI's current manufacturing sources are unable or unwilling to make
PREVATAC(TM) exisulind available to CPI in required quantities, there can be no
assurance that CPI will be able to identify and contract with alternative
contract manufacturers. CPI would incur significant costs and delays to qualify
an alternative manufacturer, which could have a material adverse effect on CPI's
business, financial condition and results of operations. The availability and
price of PREVATAC(TM) exisulind may be subject to curtailment or change due to
limitations that may be imposed under governmental regulations, suppliers'
allocations to meet the demand of other purchasers, interruptions in production
by suppliers and market and other events and conditions, which could have a
material adverse effect on CPI's business, financial condition and results of
operations. See "Manufacturing" above.

         Absence of Sales and Marketing Experience; Dependence on Third Parties.
CPI has no experience in sales, marketing or distribution. Depending upon the
marketing strategy ultimately adopted with respect to each relevant market, CPI
intends either to market its products, if developed and approved, on its own or
through relationships with pharmaceutical companies that have established
distribution systems and direct sales forces. To market any of its products
directly, CPI must develop a marketing and 


                                       28
<PAGE>   31
sales force with technical expertise and with supporting distribution
capabilities. There can be no assurance that CPI will be able to establish
in-house sales, marketing and distribution capabilities or relationships with
third parties, or that it will be successful in gaining market acceptance for
its products. To the extent that CPI enters into co-promotion or other licensing
arrangements, any revenues received by CPI will depend upon the efforts of third
parties, and there can be no assurance that such efforts will be successful. See
"Marketing and Sales" above.

         Need to Attract and Retain Key Employees and Consultants. Because of
the specialized scientific nature of CPI's business, its success is highly
dependent upon its ability to attract and retain qualified scientific and
technical personnel. CPI is highly dependent on the principal members of its
scientific and management staff and the loss of any of their services might
significantly delay or prevent the achievement of research, development or
business objectives. CPI does not maintain key-man life insurance with respect
to any of its employees, nor does it intend to secure such insurance. CPI also
relies on consultants and advisors, including the members of its Scientific
Advisory Board, to assist CPI in formulating its research and development
strategy. Retaining and attracting qualified personnel, consultants and advisors
is critical to CPI's success. In order to pursue its product development and
marketing and sales plans, CPI will be required to hire additional qualified
scientific personnel to perform research and development, as well as personnel
with expertise in clinical testing, government regulation, manufacturing and
marketing and sales. CPI faces competition for qualified individuals from
numerous pharmaceutical and biotechnology companies, universities and other
research institutions. CPI may not be able to attract and retain such
individuals on acceptable terms, if at all, and the failure to do so could have
a material adverse effect on CPI's business, financial condition and results of
operations.

         Risks Associated with Acquisition Strategy. CPI may seek to acquire and
further develop technologies, products and/or companies focused in the
prevention, diagnosis and treatment of cancer, consistent with the objective of
building an integrated pharmaceutical company focused in oncology. CPI may not
identify appropriate acquisition candidates and, if it does, may not be
successful in completing any such transactions on favorable terms, if at all. In
addition, to the extent that CPI undertakes or completes any such acquisitions,
such activities may place a strain on CPI's financial and management resources,
which could have a material adverse effect on CPI's business, financial
condition and results of operations. Also, the technologies, products and/or
companies acquired may be subject to many of the risk factors associated with
development of the Company's present technologies and product candidates to an
equal or greater degree.

         Potential Product Liability; Possible Insufficiency of Insurance. CPI's
business will expose it to potential product liability risks. These would
include risks that are inherent in the testing, manufacturing and marketing of
human therapeutic products. Clinical research involves the testing of new drugs
on human volunteers pursuant to a research plan, and such testing involves a
risk of liability for personal injury or death to patients due to, among other
reasons, possible unforeseen adverse side effects or improper administration of
the new drug. Many of these patients are already seriously ill and are at risk
of further illness or death. CPI currently has clinical trial liability
insurance in the amount of $10 million, but there can be no assurance that it
will be able to maintain such insurance. CPI could be materially and adversely
affected if it were required to pay damages or incur defense costs: (i) in
connection with a claim outside the scope of indemnity or insurance coverage;
(ii) if the indemnity, although applicable, is not performed in accordance with
the terms of the relevant contract; or (iii) if CPI's liability exceeds the
amount of applicable insurance. Similar risks would exist upon the
commercialization or marketing of any products by CPI or its partners.

         Handling and Disposal of Hazardous Materials. CPI's research and
development involves the controlled use of hazardous materials, chemicals and
various radioactive compounds. Although CPI believes that its safety procedures
for handling and disposing of such materials comply with the standards
prescribed by state and federal regulations, the risk of accidental
contamination or injury from these materials cannot be completely eliminated. In
the event of such an accident, CPI could be held liable for any damages that
result and any such liability could exceed the resources of CPI. CPI may incur
substantial costs to comply with environmental regulations if it develops
manufacturing capacity.


                                       29
<PAGE>   32
         Absence of Prior Trading Market; Potential Volatility of Stock Price;
No Dividends. Prior to November 4, 1998, there was no direct public market for
CPI Common Stock. There can be no assurance as to the degree to which an active
market in CPI Common Stock will be maintained. The market price of CPI Common
Stock, like that of the common stock of many other early-stage pharmaceutical
and biotechnology companies, is likely to be highly volatile. Factors such as
the fluctuation in CPI's operating results, comments by research analysts,
announcements of technological innovations or new commercial products by CPI (or
its subsidiaries) or its competitors, progress with clinical trials,
governmental regulations, changes in reimbursement policies, developments in
patent or other proprietary rights of CPI or its competitors, including
litigation, developments in CPI's relationships with collaborative partners, if
any, public concern as to the safety and efficacy of drugs developed by CPI and
its competitors, general market conditions and market conditions affecting the
pharmaceutical and biotechnology sectors particularly may have a significant
effect on the market price of CPI Common Stock. The price of CPI Common Stock
dropped substantially on February 2, 1999 after the Company announced that it
anticipated a delay in its commercialization plans following initial evaluation
of the unblinded data from the Phase III trial of PREVATAC(TM) exisulind in APC
(See discussion above under "Product Development"). CPI has never paid any cash
dividends and does not anticipate paying cash dividends in the foreseeable
future.

         Ownership by Directors and Executive Officers; Anti-Takeover
Provisions. CPI directors and executive officers, in the aggregate, beneficially
own approximately 23% of the outstanding shares of CPI Common Stock.
Accordingly, these stockholders, if they act in concert with others, might be
able to control many matters requiring approval by the stockholders of CPI,
including the election of directors. Moreover, CPI's Certificate of
Incorporation does not provide for cumulative voting with respect to the
election of directors. Consequently, the directors and executive officers will
be able to exercise substantial influence over the election of the members of
the CPI Board. Such concentration of ownership could have an adverse effect on
the price of the CPI Common Stock or have the effect of delaying or preventing a
change in control of CPI. In addition, certain provisions of Delaware law and
the CPI Certificate of Incorporation, including the provision in the Certificate
for a classified board of directors, could have the effect of making it more
difficult for a third party to acquire, or of discouraging a third party from
attempting to acquire, control of CPI. In December 1998 the board of directors
of the Company adopted a stockholder rights plan to enable the directors to act
in the best interests of the stockholders in the event of an actual or
threatened accumulation of stock by a third party without the consent of the
board of directors. Such provisions could limit the price that certain investors
might be willing to pay in the future for shares of CPI Common Stock. The
provisions of Delaware law, of the CPI Certificate of Incorporation and Bylaws
and of the stockholder rights plan may also have the effect of discouraging or
preventing certain types of transactions involving an actual or threatened
change of control of CPI (including unsolicited takeover attempts) even though
such a transaction may offer CPI's stockholders the opportunity to sell their
stock at a price above the prevailing market price. Certain of these provisions
allow CPI to issue preferred stock without any vote or further action by the
stockholders, require stockholders to provide advance notice prior to bringing
proposals before a meeting and prevent or eliminate cumulative voting in the
election of directors. These provisions may make it more difficult for
stockholders to take certain corporate actions and could have the effect of
delaying or preventing a change in control of CPI.

ITEM 2.  PROPERTIES

         CPI leases approximately 40,000 square feet of laboratory and office
space in Horsham, Pennsylvania under a ten-year lease which expires in 2008 and
which contains two five-year renewal options. CPI vacated its 7,900 square feet
facility in Aurora, Colorado at the end of July 1998; the lease expires in June
1999. CPI has consolidated all operations from the Aurora facility into the
Horsham facility.

ITEM 3.  LEGAL PROCEEDINGS

         Between February 12 and March 16, 1999, five stockholder class actions
were filed against the Company and certain of its officers and directors in the
United States District Court for the Eastern District of Pennsylvania seeking
unspecified damages on behalf of various classes of persons, including all
persons who purchased Company common stock between November 3, 1998 or November
11, 1998 and February 


                                       30
<PAGE>   33
2, 1999, including a subclass of former stockholders of Tseng Labs, Inc. whose
shares were exchanged for shares of the Company in the November 3 transaction
between Tseng Labs, Inc. and the Company. The complaints allege that the Company
made false and misleading statements about the efficacy and near-term
commercialization of the Company's lead drug candidate which had the effect of
artificially inflating the price of the Company's common stock. The Company
believes that the allegations are without merit and intends to vigorously
defend the litigation.

ITEM 4   SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

(a) A special meeting of the stockholders of the Company was held on November 2,
1998.

(c) The purpose of the special meeting was to consider and act upon the proposed
acquisition by the Company of Tseng Labs, Inc. and the matters incident thereto.
The proposal was adopted by the affirmative vote of 16,180,601 shares, or
approximately 87% of the shares eligible to vote thereon. Shares voted against
totaled 54,054; abstentions totaled 15,659. The Company was not a publicly
traded company at the time of the solicitation; no broker votes or non-votes
were involved. Solicitation of proxies was made through the means of a joint
proxy statement filed with the Securities and Exchange Commission as part of a
registration statement on Form S-4 which was declared effective in September of
1998, to which reference is made for details of the transaction. As a condition
to the closing of the transaction, Messrs. John J. Gibbons and Louis M. Weiner
were elected directors of the Company by the board of directors of the Company.


                                       31
<PAGE>   34
                                     PART II

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

         The common stock of the Company has been traded on the Nasdaq National
Market under the symbol CLPA since November 4, 1998. Prior to November 4, 1998,
the Company's common stock was not publicly traded. The following table sets
forth for the period indicated the high and low closing prices per share of the
common stock as reported by the Nasdaq National Market.

<TABLE>
<CAPTION>
         1998                                           HIGH            LOW
         ----                                           ----            ---
<S>                                                    <C>             <C>   
Fourth Quarter (commencing November 4, 1998)           $22.00          $9.875
</TABLE>

         As of March 15, 1999, there were approximately 1,120 holders of record
of the common stock. This does not reflect beneficial stockholders who hold
their stock in nominee or "street" name through various brokerage firms.

         During 1998, the Company did not sell any securities which were not
registered under the Securities Act of 1933 other than 765 shares of common
stock issued for $3,468 pursuant to the exercise of previously outstanding
warrants which had been issued pursuant to the exemption provided by Section
4(2) of the Securities Act. Prior to November 4, 1998, the Company's
predecessor, now its subsidiary, issued Series G Convertible Preferred Stock and
warrants and issued shares upon the exercise of a previous series of warrants,
as described in the Company's Report on Form 10-Q for the third quarter of 1998,
pursuant to the exemption provided by Section 4(2) of the Securities Act, and
issued 26,250 shares of common stock for $8,400 upon the exercise of stock
options issued to employees in prior years pursuant to the exemption from
registration under the Securities Act provided by Rule 701.

DIVIDENDS

         The Company has never paid cash dividends on its common stock and does
not expect to pay cash dividends on its common stock for the foreseeable future.


                                       32
<PAGE>   35
ITEM 6.  SELECTED FINANCIAL DATA

<TABLE>
<CAPTION>
                                                            YEAR ENDED DECEMBER 31,
                                    ----------------------------------------------------------------------------
                                        1998             1997           1996           1995            1994
                                    ------------    ------------   -------------   -------------    ------------
<S>                                 <C>             <C>             <C>             <C>             <C>         
CONSOLIDATED STATEMENT OF
OPERATIONS DATA:
Expenses:
   Research and development .....   $ 16,052,232    $  8,756,499    $  4,162,981    $  2,574,105    $  2,428,515
   General and administrative ...      4,253,537         950,057         663,030         644,407         705,912
   Provision for redemption of
     the Redeemable Preferred
     Stock ......................             --       1,017,000              --              --              --
                                    ------------    ------------    ------------    ------------    ------------

     Total expenses .............     20,305,769      10,723,556       4,826,011       3,218,512       3,134,427
Interest Income .................        960,333         426,644          90,807          27,688          23,981
                                    ------------    ------------    ------------    ------------    ------------
Net Loss ........................   $(19,345,436)   $(10,296,912)   $ (4,735,204)   $ (3,190,824)   $  (3,110,446)
                                    ============    ============    ============    ============    ============
 Basic and diluted net loss per
  Common Share ..................   $      (3.04)   $      (3.63)   $      (1.83)   $      (1.39)   $      (1.36)
                                    ------------    ------------    ------------    ------------    ------------
Shares used in computing basic
  and diluted net loss per Common
  Share .........................      6,369,006       2,838,814       2,587,552       2,296,167       2,291,306
                                    ============    ============    ============    ============    ============

                                                                  DECEMBER 31,
                                    ----------------------------------------------------------------------------
                                        1998             1997           1996           1995            1994
                                    ------------    ------------   -------------   -------------    ------------
<S>                                 <C>             <C>             <C>             <C>             <C>         
CONSOLIDATED BALANCE SHEET DATA:
   Cash and cash equivalents.....   $ 37,232,404    $  8,460,839    $    644,790    $  2,202,871    $    605,368
   Working capital (deficiency)..     33,804,194       5,384,546       (506,464)         834,785       (293,872)
   Total assets.................      40,232,699      10,978,653       1,106,371       2,329,923         704,077
   Long-term debt................        159,897           9,259          62,424              --              --
   Redeemable Preferred Stock....             --       1,092,000             613             613             613
   Common Stock..................        242,796          29,901          27,189          22,962          22,962
   Convertible Preferred Stock...             --      32,158,000      15,137,516      11,639,231       7,305,362
   Accumulated deficit ..........    (45,329,772)    (25,984,336)    (15,687,424)    (10,952,220)     (7,761,396)
   Total stockholders' equity    
     (deficit) ..................     36,132,118       6,622,429        (179,238)        901,919        (241,001)
</TABLE>

ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS

         Cell Pathways, Inc. was incorporated in Delaware in July 1998 as a
subsidiary of, and, as of November 3, 1998, the successor to, a Delaware
corporation of the same name. As the context requires, the "Company" or "CPI" is
used herein to signify the successor and/or the predecessor corporations

         Certain statements made in this report on Form 10-K, and oral
statements made with respect to this report, constitute "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. Such statements include those which express plan, anticipation, intent,
estimation, belief, contingency or future development and/or otherwise are not
statements of historical fact. These statements are subject to risks and
uncertainties, known and unknown, which could cause actual results and
developments to differ materially from those expressed or implied in such
statements. Such risks and uncertainties relate to, among other factors, the
costs, delays and uncertainties inherent in basic pharmaceutical research, drug
development and clinical trials; the uncertainty of obtaining regulatory
approval, and the timing and scope of any approval received; acceptance by
providers of healthcare reimbursement; the validity, scope and enforceability of
patents; the actions of competitors; dependence upon third parties; product
liability; and other risks detailed in CPI's reports filed under the Securities
Exchange Act of 1934, including the sections 


                                       33
<PAGE>   36
entitled "Business" and "Risk Factors" in this report on Form 10-K for the year
ending December 31, 1998. The Company undertakes no obligation to update or
revise the statements made in this report

OVERVIEW

         CPI is a development stage pharmaceutical company focused on the
research, development and future commercialization of products to prevent and
treat cancer. From the inception of the Company's business in 1990, operating
activities have related primarily to conducting research and development,
raising capital and recruiting personnel. The Company's initial investigational
new drug application ("IND") was filed with the Food and Drug Administration
("FDA") in December 1993 for human clinical trials of the Company's first
product candidate, exisulind.

         Phase I clinical trials for exisulind to treat adenomatous polyposis
coli ("APC"), an FDA designated orphan drug indication, began in February 1994;
a Phase I/II clinical trial began in August 1995; and a Phase III clinical trial
was initiated in the second quarter of 1997 and concluded in January 1999. In
December 1997, CPI initiated Phase II/III clinical trials of exisulind for the
treatment of sporadic adenomatous colonic polyps (patient enrollment continuing)
and for the prevention of prostate cancer recurrence (patient enrollment
completed in the third quarter of 1998) as well as a pilot clinical trial of
exisulind for the treatment of lung cancer. In addition, a Phase II/III clinical
trial of exisulind for prevention of breast cancer recurrence (patient
enrollment continuing) was initiated in February 1998.

         On November 3, 1998, CPI completed a financing through the acquisition
of Tseng Labs, Inc. ("Tseng")(a publicly-held company with no continuing
operations which, subsequent to the transaction, became a subsidiary of CPI), in
which CPI issued to Tseng stockholders approximately 5.5 million shares of CPI
Common Stock, which represented approximately 23% of the outstanding Common
Stock of CPI, and received net proceeds of approximately $26.4 million.

         In January 1999, CPI completed a pivotal Phase III clinical trial of
exisulind for the indication of familial polyposis coli or APC. Preliminary
evaluation of the unblinded data from this clinical trial suggested that the
trial did not achieve statistical significance. On February 1, 1999, the Company
announced that it anticipated a delay in the filing of a new drug application
("NDA") with the FDA for this indication and that the Company would be
evaluating the data in a process which was expected to continue for some weeks.
As of March 26, 1999, CPI had not completed its evaluation of the data from the
Phase III clinical trial. Until completion of its analysis, the Company will not
know the extent of delay. There can be no assurance that the Company will file
an NDA for the APC indication, or, if an NDA is filed, that exisulind will
receive marketing approval by the FDA.

         The Company has not received any revenue from the sale of products, and
no product candidate of CPI has been approved for marketing. CPI's income has
been limited to interest income from investments, and CPI's primary source of
capital has been the sale of its equity securities and the transaction with
Tseng. Annual losses were $19,345,436, $10,296,912 and $4,735,204 in 1998, 1997
and 1996, respectively. As of December 31, 1998 and 1997, CPI's accumulated
deficit was $45,329,772 and $25,984,336, respectively, and its unrestricted cash
and cash equivalents for the same periods were $37,232,404 and $8,460,839,
respectively. CPI anticipates that it will continue to incur additional
operating losses for the next several years. There can be no assurance that any
of CPI's product candidates will be approved for marketing, that CPI will attain
profitability or, if profitability is achieved, that CPI will remain profitable
on a quarterly or annual basis in the future. CPI's operating results will
fluctuate from quarter to quarter. Some of these fluctuations may be significant
and, as a result, quarter to quarter comparisons may not be meaningful.

RESULTS OF OPERATIONS

         Year Ended December 31, 1998 Compared with Year Ended December 31,
1997. Total expenses for the year ended December 31, 1998 were $20,305,769, an
increase of $9,582,213 from the same period in 1997. Such increase was primarily
due to an increase in the Company's research and development ("R&D") and general
and administrative ("G&A") expenses. R&D expenses in 1998 were $16,052,232, an
increase of $7,295,733 from 1997. Such increase was primarily due to the
procurement of clinical trial 


                                       34
<PAGE>   37
supplies of exisulind, higher expenses associated with the Company's ongoing
clinical trials, additional personnel in 1998 to support the in-house activities
of research, product development and clinical trial management and facility
expenses. G&A expenses were $4,253,537 for the year ended December 31, 1998, an
increase of $3,303,480 from the same period in 1997. Such increase was primarily
the result of additional personnel hired, a one-time charge for expenses related
to the Company's planned initial public offering which was not completed,
expenses associated with marketing and commercialization preparations and higher
facility expenses. In 1997, the Company recorded a provision of $1,017,000 for
the redemption of CPI Redeemable Preferred Stock, which was subsequently
redeemed in November 1998.

         Interest income was $960,333 in 1998, an increase of $533,689 from
1997, primarily due to higher cash balances resulting from the Series G
Convertible Preferred Stock financing in April and May 1998, which resulted in
net proceeds of $21,404,004, and the transaction with Tseng, which resulted in
net proceeds of $26,364,894.


         Year Ended December 31, 1997 Compared with Year Ended December 31,
1996. Total expenses for the year ended December 31, 1997, were $10,723,556, an
increase of $5,897,545 from the same period in 1997. Such increase was primarily
due to an increase in the Company's R&D and G&A expenses. R&D expenses in 1997
were $8,756,499, an increase of $4,593,518 from 1996. Such increase was
primarily due to the procurement of clinical trial supplies of exisulind and
cell biology research related to CPI's technology. G&A expenses were $950,057 in
1997, an increase of $287,027 from 1996, primarily due to higher personnel
related expenses for salaries, travel and recruiting. In the third quarter of
1997, CPI recorded a provision of $1,017,000 for the redemption of CPI
Redeemable Preferred Stock as CPI's preparations for a registration of its stock
made it probable that such redemption would occur.

         Interest income was $426,644, an increase of $335,837 from 1996 due to
higher cash balances resulting from the CPI Series F Preferred Stock financing
that commenced in 1996 and resulted in net proceeds of $17,547,859 in 1996 and
1997.

LIQUIDITY AND CAPITAL RESOURCES

         CPI has financed its operations since inception primarily with the net
proceeds received from private placements of equity securities and the
transaction with Tseng. Financing activities have generated net proceeds of
$81,220,197 from inception through December 31, 1998. For the years ended
December 31, 1998 and 1997, net cash generated by financing activities was
$48,791,886 and $17,082,279, respectively, primarily reflecting the sale of
equity securities in both 1998 and 1997 and the transaction with Tseng in 1998.
In 1997, the Company raised $16,547,859 from the Series F Convertible Preferred
Stock private placement and in 1998 the Company raised $21,404,004 and
$26,364,894 from the Series G Convertible Preferred Stock private placement and
the transaction with Tseng, respectively.

         At December 31, 1998, CPI had cash and cash equivalents of $37,232,404
(excluding restricted cash of $611,172). CPI's cash position increased by
$28,771,565 for the year ended December 31, 1998, primarily reflecting the net
proceeds of the private placement of Series G Preferred Stock, the transaction
with Tseng, and proceeds received upon the sale of certain leasehold
improvements less operating expenses and capital expenditures. CPI invests its
excess cash primarily in low risk, highly liquid money market funds and U.S.
government treasuries. CPI had $611,172 in a restricted account pledged as
security for a letter of credit for a security deposit under the lease of its
Horsham, Pennsylvania facility, and as security to a letter of credit for a
portion of a software lease commitment.

         In 1998, the Company acquired approximately $2,624,383 in laboratory
and computer equipment, office furniture and leasehold improvements for its new
research laboratories and offices in its Horsham Facility. The Company plans to
seek financing for the acquisition of capital assets in the future. However, the
Company has no agreements or arrangements to such financing and there can be no
assurance that such financing will be available on terms acceptable to CPI, if
at all.


                                       35
<PAGE>   38
         CPI leases approximately 40,000 square feet of laboratory and office
space in Horsham, Pennsylvania under a ten-year lease which expires in 2008
and which contains two five-year renewal options. In June 1998, CPI received a
one-time payment of $3.0 million toward improvements to the facility for
laboratories and office renovations previously made and to be made by the
Company. CPI vacated its 7,900 square feet facility in Aurora, Colorado at the
end of July 1998; the lease expires in June 1999 and the remaining rent expense
associated with such facility has been recorded in the 1998 operations. The
Company believes its facilities will be adequate for the foreseeable future.

         CPI anticipates that annual expenditures for preclinical studies,
clinical trials, product development, research, selling and marketing, and
general and administrative expense will increase significantly in future years.
In anticipation of possible FDA approval for the marketing of exisulind, CPI
began, in the second half of 1998, to prepare for the commercialization of CPI's
first product and planned to accelerate such preparation in 1999, adding
substantial additional expense. As indicated in the Company's February 1999
announcement of the preliminary evaluation of the data from the APC Phase III
clinical trial, the Company anticipates a delay in the filing of an NDA.
Accordingly, the Company is revising its current operating plan and anticipated
expenditures, and is developing contingency plans associated with its clinical
development plans. There can be no assurance that CPI will be able to
successfully complete the clinical development of exisulind for APC or any other
indication, that the FDA will grant approval within the time frame expected, if
at all, that the other developments or expansions in CPI's programs of research,
development and commercialization will not require additional funding or
encounter delays or that, in light of these or other circumstances, CPI will be
able to achieve anticipated levels of revenue, expense and cash flow.

         CPI expects that it will require additional financing to continue its
research and development programs. CPI plans to finance its anticipated growth
and development largely through equity or debt financings and/or strategic
alliances with corporate partners. CPI believes, based on its current operating
plans, that its existing cash and cash equivalents balance of approximately
$37.2 million as of December 31, 1998, together with interest earned on this
balance, but without taking into consideration any potential revenues from
possible commercialization or strategic alliances, will provide sufficient
working capital to sustain operations into the fourth quarter of 2000. However,
there can be no assurance the Company will not require additional funding prior
to that time, as the Company must adapt to changing circumstances arising from
within the Company's programs or from outside the Company. There can be no
assurance that additional equity or debt financing or corporate collaborations
will be available on terms acceptable to CPI, if at all. Any additional equity
financing would be dilutive to stockholders. Debt financing, if available, may
include restrictive covenants. Corporate alliances could require the Company to
give up certain marketing rights or other rights to its potential products and
technology. If additional funds should be needed but are not available, CPI may
be required to modify its operations significantly or to obtain funds by
entering into collaborative arrangements or other arrangements on unfavorable
terms. The failure by CPI to raise capital on acceptable terms if and when
needed would have a material adverse effect on CPI's business, financial
condition and results of operations.

INFLATION

         CPI does not believe that inflation has had any significant impact on
CPI's business to date.

INCOME TAXES

         As of December 31, 1998, CPI has net operating loss carryforwards
("NOLs") for income tax purposes available to offset future federal income tax,
subject to limitations for alternative minimum tax. In addition, the Company has
other significant deferred tax assets which will also offset future income tax.
As the Company has not yet achieved profitable operations, management believes
the tax assets do not satisfy the realization criteria of Statement of Financial
Accounting Standards ("SFAS") No. 109 "Accounting for Income Taxes" and
therefore the Company has recorded a valuation allowance for the entire amount
of its net tax asset as of December 31, 1998. (See Note 11 of notes to
consolidated financial statements included elsewhere in this report.)


                                       36
<PAGE>   39
         The Tax Reform Act of 1986 contains provisions that may limit the NOLs
available to be used in any given year upon the occurrence of certain events,
including significant changes in ownership interest. A change in ownership of a
company of greater than 50% within a three-year period results in an annual
limitation on CPI's ability to utilize its NOLs from tax periods prior to the
ownership change. CPI believes that the transaction with Tseng triggered such
limitation. However, CPI does not expect such limitation to have a significant
impact on its operations.

RECENT ACCOUNTING PRONOUNCEMENTS

         In June 1998, the Financial Accounting Standards Board issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities", which
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts
(collectively referred to as derivatives) and for hedging activities. SFAS No.
133 is effective for all fiscal quarters of fiscal years beginning after June
15, 1999. As the Company does not currently engage in derivative or hedging
activities, the Company believes that there will be no impact to the Company's
results of operations, financial position or cash flows upon the adoption of
this standard.

         In March 1998, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position ("SOP") 98-1, "Accounting for the Cost of
Computer Software Developed or Obtained for Internal Use". SOP 98-1 is effective
for financial statements for years beginning after December 15, 1998. SOP 98-1
provides guidance on accounting for computer software developed or obtained for
internal use including the requirement to capitalize specified costs and
amortization of such costs. The Company does not expect the adoption of this
standard to have a material effect on the Company's capitalization policy.

         In April 1998, the AICPA issued SOP 98-5, "Reporting on the Costs of
Start-Up Activities", which is effective for fiscal years beginning after
December 15,1998. SOP 98-5 provides guidance on the financial reporting of
start-up costs and organization costs. It requires costs of start-up activities
and organization costs to be expensed as incurred. As the Company has expensed
these costs historically, the adoption of this standard is not expected to have
a significant impact on the Company's results of operations, financial position
or cash flows.

RISKS ASSOCIATED WITH THE YEAR 2000

         The Year 2000 issue is the result of computer programs being written
using two digits rather than four to define the applicable year. In other words,
date-sensitive software may recognize a date using "00" as the year 1900 rather
than the year 2000. This could result in system failures or miscalculations
causing disruptions of operations, including, among others, a temporary
inability to process transactions and information, send invoices, or engage in
similar normal business activities.

         CPI does not believe that it has material exposure to the Year 2000
issue with respect to its own information systems. CPI has reviewed its existing
systems and believes that they correctly define the Year 2000. Non-information
technology systems that utilize embedded technology, such as microcontrollers,
HVAC, and security may also face Year 2000 issues. However, the Company believes
that it does not have significant Year 2000 issues related to non-information
technology systems and is currently reviewing these systems. This review will be
completed in 1999.

         In addition, CPI is conducting an analysis to determine the extent to
which its major suppliers', third party researchers' and clinical trial sites'
systems (insofar as they relate to CPI's business) are subject to the Year 2000
issue. This review will be completed in 1999. CPI is currently unable to predict
the extent to which it would be vulnerable to its third parties failure to
remediate any Year 2000 issues on a timely basis. The failure of a major third
party subject to the Year 2000 issue to convert its systems on a timely basis or
a conversion that is incompatible with CPI's systems could have a material
adverse effect on CPI. However, CPI's activities to date have related primarily
to conducting research and development activities and as a result are not
significantly dependent on external third-party systems. All new contractual
arrangements with third parties require assurance that the third party is Year
2000 compliant.


                                       37
<PAGE>   40
         To date CPI has not made any contingency plans to address third party
Year 2000 risks. CPI plans to formulate contingency plans to the extent
necessary in 1999. Historical and estimated costs directly related to Year 2000
issue remediation have been and are expected to be immaterial as CPI's past and
future infrastructure has been built with Year 2000 issues in mind and to
minimize these issues. Based on information now known to CPI, the Company does
not expect to incur material costs in addressing the Year 2000 issue, nor does
the Company believe that it will be required to make material capital
expenditures to fix Year 2000 issues other than system upgrades on a normal
replacement schedule with only immaterial opportunity costs of CPI personnel to
ensure new systems and third parties are Year 2000 compliant.


ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

         INTEREST RATE RISK. The Company's exposure to market risk for changes
in interest rates primarily relates to the Company's investment portfolio. The
Company is averse to principal loss and seeks to limit default risk, market risk
and reinvestment risk. In particular, the Company does not use derivative
financial instruments in its investment portfolio, places its investments with
high quality issuers and, except for investments with the U.S. Government,
limits the amount of credit exposure to any one issuer. The Company mitigates
default risk by investing in only the safest and highest credit quality
securities, predominantly those of the U.S. Government, and by positioning its
portfolio to respond appropriately to a significant reduction in a credit rating
of any investment issuer, guarantor or depository. The portfolio includes only
marketable securities with active secondary or resale markets to ensure
portfolio liquidity and has historically been invested in securities which have
original maturities of less than three months to ensure principal preservation.
As of December 31, 1998, the Company was invested in U.S. Government securities
and money market funds, which were classified as cash equivalents in the
Company's financial statements. The investments had principal (or notional)
amounts of $37,593,339 which were equal to their fair value, an average interest
rate of 5% and mature in less than three months.


ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The Registrant's financial statements and notes thereto, together with the
Report of Independent Public Accountants thereon, appear at pages F-1 through
F-19 of this report and are incorporated herein by reference.

ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND 
         FINANCIAL DISCLOSURE

         None.


                                       38
<PAGE>   41
                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

         (a) The information required by Item 10 for Directors of the Company is
contained in the Company's definitive Proxy Statement with respect to the
Company's Annual Meeting of Stockholders, to be filed with the Securities and
Exchange Commission within 120 days following the end of the Company's fiscal
year, and is incorporated herein by reference thereto.

         (b) The information required by Item 10 for Executive Officers of the
Company is set forth in Part 1 of this report and is incorporated herein by
reference thereto.

ITEM 11. EXECUTIVE COMPENSATION

         The information required by Item 11 is contained in the Company's
definitive Proxy Statement with respect to the Company's Annual Meeting of
Stockholders, to be filed with the Securities and Exchange Commission within 120
days following the end of the Company's fiscal year, and is incorporated herein
by reference thereto.



ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

         The information required by Item 12 is contained in the Company's
definitive Proxy Statement with respect to the Company's Annual Meeting of
Stockholders, to be filed with the Securities and Exchange Commission within 120
days following the end of the Company's fiscal year, and is incorporated herein
by reference thereto.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         The information required by Item 13 is contained in the Company's
definitive Proxy Statement with respect to the Company's Annual Meeting of
Stockholders, to be filed with the Securities and Exchange Commission within 120
days following the end of the Company's fiscal year, and is incorporated herein
by reference thereto.


                                       39
<PAGE>   42
                                     PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.

(A)

1.       LIST OF FINANCIAL STATEMENTS

         See page F-1 of this report, which includes an index to consolidated
         financial statements.

2.       LIST OF FINANCIAL STATEMENT SCHEDULES

         None.

3.       LIST OF EXHIBITS 

  *2.1   Agreement and Plan of Reorganization dated as of June 23, 1998 among 
         Cell Pathways, Inc. and Tseng Labs, Inc.

   3.1   Certificate of Incorporation as amended November 2, 1998.

   3.2   Amendment to Certificate of Incorporation by way of Certificate of
         Designation, Preferences and Rights of Series A Junior Participating
         Preferred Stock.

  *3.3   Bylaws of Cell Pathways Inc.

   4.1   Reference is made to Exhibits 3.1 and 3.2.

  *4.2   Specimen certificate of Registrant.

***4.3   Rights Agreement dated as of December 3, 1998 between Registrant and
         Registrar and Transfer Company.

 *10.2   Lease, dated June 25, 1998, between Cell Pathways, Inc. and ARE-702 
         Electronic Drive, L.P.

 *10.3   1997 Equity Incentive Plan of Cell Pathways, Inc.

 *10.4   Form of Incentive Stock Option Agreement.

 *10.5   1997 Non-Employee Director Stock Option Plan of Cell Pathways, Inc.

 *10.6   Form of Stock Option Agreement.

**10.7   1997 Employee Stock Purchase Plan of Cell Pathways, Inc.

**10.8   Employment Agreement, dated November 6, 1997, between Cell Pathways, 
         Inc. and Brian J. Hayden.

**10.9   1995 Stock Award Plan of Cell Pathways, Inc.

**10.10  Employment Agreement, dated October 12, 1996, between Cell Pathways, 
         Inc. and Robert J. Towarnicki.


                                       40
<PAGE>   43
**10.11  Employment Agreement, dated February 1, 1993, between Cell Pathways,
         Inc. and Rifat Pamukcu.

**10.12  Memorandum of Employment, dated January 1, 1993, between Cell Pathways,
         Inc. and Richard H. Troy.

**10.13  Agreement, dated June 30, 1994, between Cell Pathways, Inc. and the 
         Division of Cancer Prevention and control, National Cancer Institute.

**10.14  Amendment to Agreement, dated September 4, 1996, between Cell Pathways,
         Inc. and the Division of Cancer Prevention and Control, National Cancer
         Institute.

**10.15  Research and License Agreement, dated June 26, 1991, between Cell 
         Pathways, Inc. and the University of Arizona, as amended.

 *10.17  Severance Agreement, dated April 17, 1998, between Tseng Labs, Inc. 
         and John J. Gibbons.

  22.1   Subsidiaries

  23.1   Consent of Arthur Andersen LLP

  24.1   Power of Attorney. Reference is made to the signature page of this
         report.

  27.1   Financial Data Schedule as of and for the period ended December 31,
         1998.

*        Previously filed as an exhibit to Registrant's Registration Statement
         on Form S-4 (No. 333-59557), filed July 22, 1998, or amendments
         thereto, and incorporated herein by reference.

**       Previously filed as an exhibit to Registrant's Registration Statement
         on Form S-1 (No. 333-37557), filed October 9, 1997 or amendments
         thereto, and incorporated herein by reference.

***      Previously filed as an exhibit to Registrant's Report on Form 8-K filed
         December 18, 1998.

(b)      REPORT ON FORM 8-K

A report on Form 8-K was filed on December 18, 1998 to report under Item 5 Other
Events with respect to the adoption of a Stockholder Rights Plan.


                                       41
<PAGE>   44
                                   SIGNATURES

         Pursuant to the requirements of Section 13 or 15(d) of the Securities
and Exchange Act of 1934, the Registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.

                           CELL PATHWAYS, INC.

                           By: /s/ Robert J. Towarnicki
                              ............................
                           President, Chief Executive Officer and Director
March 26, 1999             (Principal Executive Officer)

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Robert J. Towarnicki and Richard H. Troy and each
of them, his or her true and lawful attorney-in-fact and agents, with the full
power of substitution and resubstitution, for such person and in each person's
name, place and stead, in any and all capacities, to sign this report and any
and all amendments to this report, and to file the same, with exhibits thereto
and other documents in connection therewith, with the Securities and Exchange
Commission, granting unto said attorneys-in-fact and agents, full power and
authority to do and perform each and every act and thing requisite and necessary
to be done as fully to all intents and purposes as he or she might or could do
in person, hereby ratifying and confirming all that said attorney-in-fact and
agents, and any of them, may lawfully do or cause to be done by virtue hereof.

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

<TABLE>
<CAPTION>
         Signature                    Title                          Date
         ---------                    -----                          ----
<S>                                   <C>                            <C>
/s/  WILLIAM A. BOEGER
 ..................................    Chairman of the Board of       March 26, 1999
         (William A. Boeger)             Directors

/s/  John J. Gibbons
 ..................................    Director                       March 26, 1999
         (John J. Gibbons)

/s/  Thomas M. Gibson
 ..................................    Director                       March 26, 1999
         (Thomas M. Gibson)

/s/  Judith A. Hemberger
 ..................................    Director                       March 26, 1999
         (Judith A. Hemberger)

/s/  Roger J. Quy
 ..................................    Director                       March 26, 1999
         (Roger J. Quy)

/s/  Bruce R. Ross
 ..................................    Director                       March 26, 1999
         (Bruce R. Ross)
</TABLE>


                                       42
<PAGE>   45
<TABLE>
<CAPTION>
         Signature                    Title                          Date
         ---------                    -----                          ----
<S>                                   <C>                            <C>
/s/  Peter G. Schiff
 ..................................    Director                       March 26, 1999
         (Peter G. Schiff)

/s/  Randall M. Toig
 ..................................    Director                       March 26, 1999
         (Randall M. Toig)


/s/  ROBERT J. TOWARNICKI
 ..................................    President, Chief Executive     March 26, 1999
         (Robert J. Towarnicki)        Officer and Director

/s/  Richard H. Troy
 ..................................    Senior Vice President,         March 26, 1999
         (Richard H. Troy)             Corporate Development,
                                       General Counsel, Secretary
                                       and Director
/s/  Louis M. Weiner
 ....................................  Director                       March 26, 1999
         (Louis M. Wiener)

/s/  BRIAN J. HAYDEN
 ....................................  Chief Financial Officer        March 26, 1999
         (Brian J. Hayden)             Vice President, Finance
                                       (Principal Financial and
                                       Accounting Officer)
</TABLE>


                                       43
<PAGE>   46
                               CELL PATHWAYS, INC.

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS


Consolidated Financial Statements:

<TABLE>
<CAPTION>
                                                                     Page
                                                                     ----
<S>                                                                  <C>
Report of Independent Accountants..................................  F-2

Consolidated Balance Sheets as of December 31, 1998 and 1997.......  F-3

Consolidated Statements of Operations for the years ended
December 31, 1998, 1997 and 1996 and for the period from inception
(August 10, 1990) to December 31, 1998.............................  F-4

Consolidated Statements of Stockholders' Equity (Deficit) and
Partners' Investment for the period from inception (August
10, 1990) to December 31, 1998.....................................  F-5 to F-8

Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996 and the period from inception
(August 10, 1990) to December 31, 1998.............................  F-9

Notes to Financial Statements .....................................  F-10 to F-19
</TABLE>


                                      F-1
<PAGE>   47
                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS



To Cell Pathways, Inc.:

We have audited the accompanying consolidated balance sheets of Cell Pathways,
Inc. (a Delaware corporation in the development stage), as of December 31, 1998
and 1997 and the related consolidated statements of operations, stockholders'
equity (deficit) and partners' investment, and cash flows for each of the three
years in the period ended December 31, 1998 and for the period from inception
(August 10, 1990) to December 31, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these 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 financial statements referred to above present fairly, in
all material respects, the financial position of Cell Pathways, Inc. as of
December 31, 1998 and 1997 and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 1998 and for the
period from inception (August 10, 1990) to December 31, 1998, in conformity with
generally accepted accounting principles.


                                         /s/ Arthur Andersen LLP




Philadelphia, Pennsylvania
March 16, 1999


                                      F-2
<PAGE>   48
                               CELL PATHWAYS, INC.
                          (A DEVELOPMENT STAGE COMPANY)

                           CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                                            DECEMBER 31,
                                                                                    -----------------------------
                                                                                        1998             1997
                                                                                    ------------     ------------
<S>                                                                                 <C>              <C>
                              ASSETS
CURRENT ASSETS:
  Cash and cash equivalents ....................................................    $ 37,232,404     $  8,460,839
  Prepaid expenses and other ...................................................         512,474          178,672
                                                                                    ------------     ------------
  Total current assets .........................................................      37,744,878        8,639,511

EQUIPMENT, FURNITURE AND LEASEHOLD IMPROVEMENTS, NET
  (NOTE 4) .....................................................................       1,533,634        1,642,597
RESTRICTED CASH ................................................................         611,172          198,592
OTHER ASSETS ...................................................................         343,015          497,953
                                                                                    ------------     ------------

                                                                                    $ 40,232,699     $ 10,978,653
                                                                                    ============     ============
               LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
  Current installments of obligations under capital lease ......................    $    146,260     $         --
  Accounts payable .............................................................         601,988          209,322
  Accrued leasehold improvement costs ..........................................         161,280        1,053,168
  Accrued compensation .........................................................         250,056          180,000
  Accrued transaction and offering costs .......................................         996,720          441,427
  Other accrued liabilities (NOTE 5) ...........................................       1,784,380        1,317,805
  Note payable .................................................................              --           53,243
                                                                                    ------------     ------------
  Total current liabilities ....................................................       3,940,684        3,254,965
LONG-TERM LIABILITIES:
  Obligations under capital lease, excluding current installments ..............         159,897               --
  Note payable, net of current portion .........................................              --            9,259
COMMITMENTS AND CONTINGENCIES (NOTE 12)
REDEEMABLE PREFERRED STOCK, $.01 par value, none and 61,250 shares
  authorized, issued and outstanding, redeemable for $0 and $1,092,000 .........              --        1,092,000
                                                                                    ------------     ------------

STOCKHOLDERS' EQUITY :
Preferred Stock, $.01 par value, 5,000,000 and 13,000,000 shares authorized,
  none and 10,968,387 shares of Convertible Preferred Stock outstanding, with an
  aggregate liquidation  preference of $0 and  $33,091,790 .....................              --       32,158,000
Common Stock $.01 par value, 70,000,000 and 17,000,000 shares authorized;
  24,279,526 and 2,990,095 shares issued and outstanding .......................         242,796           29,901
Additional paid-in capital .....................................................      81,256,094          455,864
Stock subscription receivable from issuance of Common Stock ....................         (37,000)         (37,000)
Deficit accumulated during the development stage ...............................     (45,329,772)     (25,984,336)
                                                                                    ------------     ------------
  Total stockholders' equity ...................................................      36,132,118        6,622,429
                                                                                    ------------     ------------
                                                                                    $ 40,232,699     $ 10,978,653
                                                                                    ============     ============
</TABLE>

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


                                      F-3
<PAGE>   49
                               CELL PATHWAYS, INC.
                          (A DEVELOPMENT STAGE COMPANY)

                      CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                                                                       PERIOD
                                                          YEAR ENDED DECEMBER 31,                  FROM INCEPTION
                                               ---------------------------------------------     (AUGUST 10, 1990)
                                                  1998              1997            1996        TO DECEMBER 31, 1998
                                               ------------     ------------     -----------    --------------------
<S>                                            <C>              <C>              <C>            <C>
EXPENSES:
   Research and development ...............    $ 16,052,232     $  8,756,499     $ 4,162,981         $ 37,128,330
   General and administrative .............       4,253,537          950,057         663,030            8,809,045
   Provision for redemption of the
     Redeemable Preferred Stock ...........              --        1,017,000              --            1,017,000
                                               ------------     ------------     -----------         ------------
     Total expenses .......................      20,305,769       10,723,556       4,826,011           46,954,375
INTEREST INCOME ...........................         960,333          426,644          90,807            1,624,603
                                               ------------     ------------     -----------         ------------
NET LOSS ..................................    $(19,345,436)    $(10,296,912)    $(4,735,204)        $(45,329,772)
                                               ============     ============     ===========         ============
Basic and diluted net loss per Common Share    $      (3.04)    $      (3.63)    $     (1.83)
                                               ============     ============     ===========
Shares used in computing basic and
   diluted net loss per Common Share ......       6,369,006        2,838,814       2,587,552
                                               ============     ============     ===========
</TABLE>

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


                                      F-4
<PAGE>   50
                               CELL PATHWAYS, INC.
                          (A DEVELOPMENT STAGE COMPANY)

     CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT) AND PARTNERS'
INVESTMENT FOR THE PERIOD FROM INCEPTION (AUGUST 10, 1990) TO DECEMBER 31, 1998

<TABLE>
<CAPTION>



                                                                    REDEEMABLE           CONVERTIBLE
                                                                  PREFERRED STOCK      PREFERRED STOCK           COMMON STOCK
                                                   PARTNERS'     -----------------   --------------------    --------------------
                                                  INVESTMENT      SHARES    AMOUNT   SHARES      AMOUNT        SHARES      AMOUNT
                                                  ----------      ------    ------   ------    ----------    ---------    -------
<S>                                               <C>             <C>       <C>     <C>        <C>           <C>          <C>
BALANCE, Inception (August 10, 1990) .........    $        --         --    $ --         --    $       --           --    $    --
 Partner cash contributions in September
   1990 for Class A Partnership Units ........        406,000         --      --         --            --           --         --
 Partner contribution of interest in
   research grant in September 1990
   for Class A Partnership Units, at
   historical cost ...........................         48,638         --      --         --            --           --         --
 Net loss ....................................             --         --      --         --            --           --         --
                                                  -----------     ------    ----    -------    ----------    ---------    -------
BALANCE, December 31, 1990 ...................        454,638         --      --         --            --           --         --
 Partner cash contributions in March 1991
   for Class A Partnership Units .............        406,000         --      --         --            --           --         --
 Partner cash contributions in December
   1991 for Class B Partnership Units ........        896,563         --      --         --            --           --         --
 Net loss ....................................             --         --      --         --            --           --         --
                                                  -----------     ------    ----    -------    ----------    ---------    -------
BALANCE, December 31, 1991 ...................      1,757,201         --      --         --            --           --         --
 Partner cash contributions in January and
   April 1992 for Class B Partnership Units ..         21,812         --      --         --            --           --         --
 Partner cash contributions in December
   1992 for Class B Partnership Units ........        133,300         --      --         --            --           --         --
 Partner cash contributions in December
   1992 for Class C Partnership Units ........      1,540,000         --      --         --            --           --         --
 Partner cash contributions in December
   1992 for Class D Partnership Units ........      1,475,027         --      --         --            --           --         --
 Net loss ....................................             --         --      --         --            --           --         --
                                                  -----------     ------    ----    -------    ----------    ---------    -------
BALANCE, December 31, 1992 ...................      4,927,340         --      --         --            --           --         --
 Partner cash contributions in January 1993
   to March 1993 for Class D Partnership Units        385,015         --      --         --            --           --         --
 Exchange of interests in the Partnership
   in September 1993 for 872,000 shares of
   Series A Convertible Preferred Stock ......       (812,000)        --      --    872,400       812,000           --         --
 Exchange of interests in the Partnership
   in September 1993 for 848,100 shares of
   Series B Convertible Preferred Stock ......       (868,000)        --      --    848,100       868,000           --         --
 Exchange of interests in the Partnership
   in September 1993 for 700,000 shares of
   Series C Convertible Preferred Stock ......     (1,540,000)        --      --    700,000     1,540,000           --         --
 Exchange of interests in the Partnership
   in September 1993 for 616,808 shares of
   Series D Convertible Preferred Stock ......     (1,860,042)        --      --    616,808     1,860,042           --         --
 Exchange of interests in the Partnership
   in September 1993 for 61,250 shares of
   Redeemable Preferred Stock ................           (613)    61,250     613         --            --           --         --
 Exchange of interests in the Partnership
   in September 1993 for 2,279,500 shares of
   Common Stock ..............................       (231,700)        --      --         --            --    2,279,500     22,795
 Net loss ....................................    $        --         --    $ --         --    $       --           --    $    --
                                                  -----------     ------    ----    -------    ----------    ---------    -------
</TABLE>

<TABLE>
<CAPTION>
                                                                  STOCK          STOCK
                                                               SUBSCRIPTION   SUBSCRIPTION
                                                                RECEIVABLE     RECEIVABLE      DEFICIT
                                                                   FROM           FROM       ACCUMULATED
                                                 ADDITIONAL     ISSUANCE OF    ISSUANCE OF   DURING THE
                                                  PAID-IN      CONVERTIBLE       COMMON      DEVELOPMENT
                                                  CAPITAL    PREFERRED STOCK      STOCK        STAGE
                                                 ----------  ---------------  ------------   -----------
<S>                                              <C>         <C>              <C>            <C>
BALANCE, Inception (August 10, 1990) .........    $     --         $ --           $ --       $        --
 Partner cash contributions in September
   1990 for Class A Partnership Units ........          --           --             --                --
 Partner contribution of interest in
   research grant in September 1990
   for Class A Partnership Units, at
   historical cost ...........................          --           --             --                --
 Net loss ....................................          --           --             --          (252,116)
                                                  --------         ----           ----       -----------
BALANCE, December 31, 1990 ...................          --           --             --          (252,116)
 Partner cash contributions in March 1991
   for Class A Partnership Units .............          --           --             --                --
 Partner cash contributions in December
   1991 for Class B Partnership Units ........          --           --             --                --
 Net loss ....................................          --           --             --          (738,204)
                                                  --------         ----           ----       -----------
BALANCE, December 31, 1991 ...................          --           --             --          (990,320)
 Partner cash contributions in January and
   April 1992 for Class B Partnership Units ..          --           --             --                --
 Partner cash contributions in December
   1992 for Class B Partnership Units ........          --           --             --                --
 Partner cash contributions in December
   1992 for Class C Partnership Units ........          --           --             --                --
 Partner cash contributions in December
   1992 for Class D Partnership Units ........          --           --             --                --
 Net loss ....................................          --           --             --        (1,391,531)
                                                  --------         ----           ----       -----------
BALANCE, December 31, 1992 ...................          --           --             --        (2,381,851)
 Partner cash contributions in January 1993
   to March 1993 for Class D Partnership Units          --           --             --                --
 Exchange of interests in the Partnership
   in September 1993 for 872,000 shares of
   Series A Convertible Preferred Stock ......          --           --             --                --
 Exchange of interests in the Partnership
   in September 1993 for 848,100 shares of
   Series B Convertible Preferred Stock ......          --           --             --                --
 Exchange of interests in the Partnership
   in September 1993 for 700,000 shares of
   Series C Convertible Preferred Stock ......          --           --             --                --
 Exchange of interests in the Partnership
   in September 1993 for 616,808 shares of
   Series D Convertible Preferred Stock ......          --           --             --                --
 Exchange of interests in the Partnership
   in September 1993 for 61,250 shares of
   Redeemable Preferred Stock ................          --           --             --                --
 Exchange of interests in the Partnership
   in September 1993 for 2,279,500 shares of
   Common Stock ..............................     208,905           --             --                --
 Net loss ....................................    $     --         $ --           $ --       $(2,269,099)
                                                  --------         ----           ----       -----------
</TABLE>

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


                                      F-5
<PAGE>   51
                               CELL PATHWAYS, INC.
                          (A DEVELOPMENT STAGE COMPANY)

           CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
                     AND PARTNERS' INVESTMENT -- (CONTINUED)
      FOR THE PERIOD FROM INCEPTION (AUGUST 10, 1990) TO DECEMBER 31, 1998

<TABLE>
<CAPTION>


                                                                  REDEEMABLE            CONVERTIBLE
                                                                PREFERRED STOCK       PREFERRED STOCK             COMMON STOCK
                                                               ----------------  -------------------------     --------------------
                                                    PARTNERS'
                                                   INVESTMENT  SHARES    AMOUNT    SHARES        AMOUNT         SHARES       AMOUNT
                                                   ----------  ------    ------  ----------    -----------     ---------    -------
<S>                                                <C>         <C>       <C>     <C>           <C>            <C>           <C>
BALANCE, December 31, 1993 ....................      $ --      61,250    $  613   3,037,308    $ 5,080,042     2,279,500    $22,795
 Issuance of Common Stock for services valued
   at $0.41 per share .........................        --          --        --          --             --        16,667        167
 Issuance of 542,761 shares of Series E
   Convertible Preferred Stock for cash at
   $4.10 per share ............................        --          --        --     542,761      2,225,320            --         --
 Net loss .....................................                    --        --          --             --            --         --
                                                     ----      ------    ------  ----------    -----------    ----------    -------
BALANCE, December 31, 1994 ....................        --      61,250       613   3,580,069      7,305,362     2,296,167     22,962
 Issuance of 1,121,800 shares of Series E
   Convertible Preferred Stock for cash at
   $3.15 per share ............................        --          --        --   1,121,800      3,533,670            --         --
 Issuance of 163,701 shares of Series E
   Convertible Preferred Stock to effect the
   price change from $4.10 to $3.15 (Note 6) ..        --          --        --     163,701             --            --         --
 Conversion of bridge notes payable plus
   interest to 253,633 shares of Series E
   Convertible Preferred Stock at a price of
   $3.15 per share (Note 6) ...................        --          --        --     253,633        800,199            --         --
 Net loss .....................................                    --        --          --             --            --         --
                                                     ----      ------    ------  ----------    -----------    ----------    -------
BALANCE, December 31, 1995 ....................        --      61,250       613   5,119,203     11,639,231     2,296,167     22,962
 Issuance of 887,661 shares of Series E
   Convertible Preferred Stock for cash at
   $3.15 per share, net of offering costs of
   $298,313 ...................................        --          --        --     887,661      2,497,819            --         --
 Collection of Series E Convertible Preferred
   Stock subscription receivable ..............        --          --        --          --             --            --         --
 Issuance of 270,270 shares of Series F
   Convertible Preferred Stock for cash at
   $3.70 per share ............................        --          --        --     270,270      1,000,000            --         --
 Issuance of 185,000 shares of Common Stock in
   February 1996 as bonuses to officers and 
   employees valued at $0.32 per share ........        --          --        --          --             --       185,000      1,850
 Issuance of 14,828 shares of Common Stock in
   May 1996 for consulting services, valued at
   $0.32 per share ............................        --          --        --          --             --        14,828        148
 Exercise of warrants to purchase 148 shares of
   Series E Convertible Preferred Stock at 
   $3.15 per share ............................        --          --        --         148            466            --         --
 Exercise of options to purchase Common Stock
   at $0.32 per share .........................        --          --        --          --             --       222,850      2,229
 Net loss .....................................        --          --    $   --          --    $        --            --    $    --
                                                     ----      ------    ------  ----------    -----------    ----------    -------
</TABLE>

<TABLE>
<CAPTION>
                                                                    STOCK           STOCK
                                                                 SUBSCRIPTION     SUBSCRIPTION
                                                                  RECEIVABLE      RECEIVABLE         DEFICIT
                                                                     FROM            FROM          ACCUMULATED
                                                    ADDITIONAL    ISSUANCE OF     ISSUANCE OF      DURING THE
                                                     PAID-IN     CONVERTIBLE        COMMON         DEVELOPMENT
                                                     CAPITAL    PREFERRED STOCK      STOCK            STAGE
                                                    ----------  ---------------   ------------    -------------
<S>                                                       <C>   <C>               <C>             <C>
BALANCE, December 31, 1993 ....................      $208,905      $     --       $        --     $ (4,650,950)
 Issuance of Common Stock for services valued
   at $0.41 per share .........................         6,667            --                --               --
 Issuance of 542,761 shares of Series E
   Convertible Preferred Stock for cash at
   $4.10 per share ............................            --       (23,501)               --               --
 Net loss .....................................            --            --                --       (3,110,446)
                                                     --------      --------       -----------     ------------
BALANCE, December 31, 1994 ....................       215,572       (23,501)               --       (7,761,396)
 Issuance of 1,121,800 shares of Series E
   Convertible Preferred Stock for cash at
   $3.15 per share ............................            --          (125)               --               --
 Issuance of 163,701 shares of Series E
   Convertible Preferred Stock to effect the
   price change from $4.10 to $3.15 (Note 6) ..            --            --                --               --
 Conversion of bridge notes payable plus
   interest to 253,633 shares of Series E
   Convertible Preferred Stock at a price of
   $3.15 per share (Note 6) ...................            --            --                --               --
 Net loss .....................................            --            --                --       (3,190,824)
                                                     --------      --------       -----------     ------------
BALANCE, December 31, 1995 ....................       215,572       (23,626)               --      (10,952,220)
 Issuance of 887,661 shares of Series E
   Convertible Preferred Stock for cash at
   $3.15 per share, net of offering costs of
   $298,313 ...................................            --            --                --               --
 Collection of Series E Convertible Preferred
   Stock subscription receivable ..............            --        20,505                --               --
 Issuance of 270,270 shares of Series F
   Convertible Preferred Stock for cash at
   $3.70 per share ............................            --            --                --               --
 Issuance of 185,000 shares of Common Stock in
   February 1996 as bonuses to officers and 
   employees valued at $0.32 per share ........        57,350            --                --               --
 Issuance of 14,828 shares of Common Stock in
   May 1996 for consulting services, valued at
   $0.32 per share ............................         4,596            --                --               --   
 Exercise of warrants to purchase 148 shares of
   Series E Convertible Preferred Stock at 
   $3.15 per share ............................            --            --                --               --
 Exercise of options to purchase Common Stock
   at $0.32 per share .........................        69,084            --                --               --
 Net loss .....................................      $     --       $    --       $        --       (4,735,204)
                                                     --------      --------       -----------     ------------
</TABLE>

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


                                      F-6
<PAGE>   52
                               CELL PATHWAYS, INC.
                          (A DEVELOPMENT STAGE COMPANY)

            CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
                    AND PARTNERS' INVESTMENT -- (CONTINUED)
      FOR THE PERIOD FROM INCEPTION (AUGUST 10, 1990) TO DECEMBER 31, 1998

<TABLE>
<CAPTION>


                                                                REDEEMABLE               CONVERTIBLE
                                                              PREFERRED STOCK           PREFERRED STOCK            COMMON STOCK
                                                           ---------------------   ------------------------   ---------------------
                                               PARTNERS'
                                              INVESTMENT   SHARES       AMOUNT      SHARES        AMOUNT       SHARES       AMOUNT
                                              ----------   ------     ----------   ---------    -----------   ---------    --------

<S>                                           <C>          <C>        <C>          <C>          <C>           <C>          <C>
BALANCE, December 31, 1996 ................    $    --     61,250     $      613   6,277,282    $15,137,516   2,718,845    $ 27,189
 Issuance of 4,538,675 shares of Series F
   Convertible Preferred Stock for cash at
   $3.70 per share, net of offering costs
   of $249,239 ............................         --         --             --   4,538,675     16,547,859          --          --
 Exercise of warrants to purchase 149,462
   shares of Series E Convertible Preferred
   Stock at $3.15 per share ...............         --         --             --     149,462        470,805          --          --
 Exercise of warrants to purchase 492
   Shares of Series F Convertible Preferred
   Stock at $3.70 per share ...............         --         --             --         492          1,820          --          --
 Cashless exercise of warrants to purchase
   2,476 shares of Series E Convertible
   Preferred Stock ........................         --         --             --       2,476             --          --          --
 Exercise of options by employees and
   Directors at $0.32 - $0.50 per Share ...         --         --             --          --             --     251,250       2,512
 Issuance of Common Stock to director at
   $3.70 per share ........................         --         --             --          --             --      10,000         100
 Issuance of Common Stock to consultant,
   valued at $3.70 per share ..............         --         --             --          --             --      10,000         100
 Collection of stock subscription
   receivable .............................         --         --             --          --             --          --          --
 Provision for redemption of Redeemable
   Preferred Stock ........................         --         --      1,091,387          --             --          --          --

 Net loss .................................    $    --         --     $       --          --    $        --          --    $     --
                                               -------     ------     ----------   ---------    -----------   ---------    --------
</TABLE>


<TABLE>
<CAPTION>
                                                               STOCK           STOCK
                                                            SUBSCRIPTION     SUBSCRIPTION
                                                             RECEIVABLE       RECEIVABLE        DEFICIT
                                                                FROM             FROM         ACCUMULATED
                                              ADDITIONAL     ISSUANCE OF      ISSUANCE OF      DURING THE
                                               PAID-IN       CONVERTIBLE        COMMON        DEVELOPMENT
                                               CAPITAL     PREFERRED STOCK       STOCK           STAGE
                                              ----------   ---------------   ------------     ------------

<S>                                           <C>          <C>               <C>             <C>
BALANCE, December 31, 1996 ................   $ 346,602        $(3,121)       $     --        $(15,687,424)
 Issuance of 4,538,675 shares of Series F
   Convertible Preferred Stock for cash at
   $3.70 per share, net of offering costs
   of $249,239 ............................          --             --              --                  --
 Exercise of warrants to purchase 149,462
   shares of Series E Convertible Preferred
   Stock at $3.15 per share ...............          --             --              --                  --
 Exercise of warrants to purchase 492
   Shares of Series F Convertible Preferred
   Stock at $3.70 per share ...............          --             --              --                  --
 Cashless exercise of warrants to purchase
   2,476 shares of Series E Convertible
   Preferred Stock ........................          --             --              --                  --
 Exercise of options by employees and
   Directors at $0.32 - $0.50 per Share ...     109,462             --              --                  --
 Issuance of Common Stock to director at
   $3.70 per share ........................      36,900             --         (37,000)                 --
 Issuance of Common Stock to consultant,
   valued at $3.70 per share ..............      36,900             --              --                  --
 Collection of stock subscription
   receivable .............................          --          3,121              --                  --
 Provision for redemption of Redeemable
   Preferred Stock ........................     (74,000)            --              --                  --

 Net loss .................................   $      --        $    --        $     --        $(10,296,912)
                                              ---------        -------        --------        ------------
</TABLE>


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


                                      F-7
<PAGE>   53
                               CELL PATHWAYS, INC.
                          (A DEVELOPMENT STAGE COMPANY)

            CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
                     AND PARTNERS' INVESTMENT -- (CONTINUED)
      FOR THE PERIOD FROM INCEPTION (AUGUST 10, 1990) TO DECEMBER 31, 1998

<TABLE>
<CAPTION>
                                                                       REDEEMABLE                 CONVERTIBLE
                                                                    PREFERRED STOCK             PREFERRED STOCK
                                                                 ----------------------    -------------------------
                                                     PARTNERS'
                                                    INVESTMENT    SHARES      AMOUNT         SHARES        AMOUNT
                                                    ----------   -------   ------------    ----------   ------------
<S>                                                 <C>          <C>       <C>             <C>          <C>
BALANCE, December 31, 1997 ......................   $      --     61,250   $  1,092,000    10,968,387   $ 32,158,000
 Issuance of 4,645,879 shares of Series G
   Convertible Preferred Stock at $4.75 per
   share, net of offering costs of $663,921 .....          --         --             --     4,645,879     21,404,004
Exercise of warrants to purchase 65,076 shares of
   Series E Convertible Preferred Stock at $3.15
   per share ....................................          --         --             --        65,076        204,987
Exercise of options by employees at $0.32 -
   $8.09 per share ..............................          --         --             --            --             --
Redemption of Redeemable Preferred Stock
  for $546,051 and 33,052 shares of Common
  Stock .........................................          --    (61,250)    (1,092,000)           --             --
Conversion of Preferred Stock to Common Stock
   triggered by the transaction with Tseng       
   Labs, Inc. ...................................          --         --             --   (15,679,342)   (53,766,991)
Issuance of Common Stock in exchange for the
   Common Stock of Tseng Labs, Inc., net of 
   transaction costs of $1,907,354 ..............          --         --             --            --             --
Exercise of Series F warrants to purchase
   150 shares of Common Stock at $3.70 per share           --         --             --            --             --
Exercise of Series G warrants to purchase 615
   shares of Common Stock at $4.75 per share ....          --         --             --            --             --
Non-employee stock option expense ...............                     --             --            --             --

Net loss ........................................                     --             --            --             --
                                                    ---------    -------   ------------    ----------   ------------
BALANCE, December 31, 1998 ......................   $      --         --   $         --            --   $         --
                                                    =========    =======   ============    ==========   ============
</TABLE>


<TABLE>
<CAPTION>
                                                                                                  STOCK            STOCK
                                                                                               SUBSCRIPTION     SUBSCRIPTION
                                                                                                RECEIVABLE       RECEIVABLE
                                                           COMMON STOCK                            FROM             FROM
                                                    ------------------------    ADDITIONAL      ISSUANCE OF      ISSUANCE OF
                                                                                 PAID-IN        CONVERTIBLE        COMMON
                                                       SHARES      AMOUNT        CAPITAL      PREFERRED STOCK       STOCK
                                                    ----------   -----------   -----------    ---------------   ------------
<S>                                                 <C>          <C>           <C>            <C>               <C>
BALANCE, December 31, 1997 ......................    2,990,095   $    29,901   $   455,864       $      --       $  (37,000)
 Issuance of 4,645,879 shares of Series G
   Convertible Preferred Stock at $4.75 per
   share, net of offering costs of $663,921 .....           --            --            --              --               --
Exercise of warrants to purchase 65,076 shares of
   Series E Convertible Preferred Stock at $3.15
   per share ....................................           --            --            --              --               --
Exercise of options by employees at $0.32 -
   $8.09 per share ..............................       65,500           655       262,739              --               --
Redemption of Redeemable Preferred Stock
  for $546,051 and 33,052 shares of Common
  Stock .........................................       33,052           331       545,618              --               --
Conversion of Preferred Stock to Common Stock
   triggered by the transaction with Tseng 
   Labs, Inc. ...................................   15,679,342       156,793    53,610,198              --               --
Issuance of Common Stock in exchange for the
   Common Stock of Tseng Labs, Inc., net of
   transaction costs of $1,907,354 ..............    5,510,772        55,108    26,364,894              --               --
Exercise of Series F warrants to purchase
   150 shares of Common Stock at $3.70 per share           150             2           553              --               --
Exercise of Series G warrants to purchase 615
   shares of Common Stock at $4.75 per share ....          615             6         2,915              --               --
Non-employee stock option expense ...............           --            --        13,313              --               --

Net loss ........................................           --            --            --              --               --
                                                    ----------   -----------   -----------       ---------       ----------
BALANCE, December 31, 1998 ......................   24,279,526   $   242,796   $81,256,094       $      --       $  (37,000)
                                                    ==========   ===========   ===========       =========       ==========
</TABLE>


<TABLE>
<CAPTION>
                                                      DEFICIT
                                                    ACCUMULATED
                                                     DURING THE
                                                     DEVELOPMENT
                                                        STAGE
                                                    ------------
<S>                                                 <C>
BALANCE, December 31, 1997 ......................   $(25,984,336)
 Issuance of 4,645,879 shares of Series G
   Convertible Preferred Stock at $4.75 per
   share, net of offering costs of $663,921 .....             --
Exercise of warrants to purchase 65,076 shares of
   Series E Convertible Preferred Stock at $3.15
   per share ....................................             --
Exercise of options by employees at $0.32 -
   $8.09 per share ..............................             --
Redemption of Redeemable Preferred Stock
  for $546,051 and 33,052 shares of Common
  Stock .........................................             --
Conversion of Preferred Stock to Common Stock
   triggered by the transaction with Tseng 
   Labs, Inc. ...................................             --
Issuance of Common Stock in exchange for the
   Common Stock of Tseng Labs, Inc., net of 
   transaction costs of $1,907,354 ..............             --
Exercise of Series F warrants to purchase
   150 shares of Common Stock at $3.70 per share              --
Exercise of Series G warrants to purchase 615
   shares of Common Stock at $4.75 per share ....             --
Non-employee stock option expense ...............             --

Net loss ........................................    (19,345,436)
                                                    ------------
BALANCE, December 31, 1998 ......................   $(45,329,772)
                                                    ============
</TABLE>


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


                                      F-8
<PAGE>   54
                               CELL PATHWAYS, INC.
                          (A DEVELOPMENT STAGE COMPANY)

                      CONSOLIDATED STATEMENTS OF CASH FLOWS


<TABLE>
<CAPTION>
                                                                                                             PERIOD FROM
                                                                           YEAR ENDED                         INCEPTION
                                                                           DECEMBER 31,                      (AUGUST 10,
                                                          --------------------------------------------         1990) TO
                                                              1998            1997            1996        DECEMBER 31, 1998
                                                          -----------------------------------------------------------------
<S>                                                       <C>             <C>             <C>                <C>          

OPERATING ACTIVITIES:
   Net loss ...........................................   $(19,345,436)   $(10,296,912)   $ (4,735,204)      $(45,329,772)
Adjustments to reconcile net loss to net cash used in                                                        
   operating activities                                                                                      
   Depreciation expense and amortization ..............        255,197          61,782          33,116            388,017
   Issuance of Common Stock for services rendered .....             --          37,000           4,745             48,578
  Issuance of Common Stock options for services                                                              
       rendered .......................................         13,313              --              --             13,313
   Provision for redemption of Redeemable                                                                    
   Preferred Stock ....................................             --       1,017,387              --          1,017,387
   Write-off of deferred offering costs ...............        469,515              --              --            469,515
   Other ..............................................             --              --              --             68,399
   Increase in prepaid and other current assets .......        (15,176)       (106,882)        (12,484)          (193,848)
   Increase in other assets ...........................       (208,248)             --              --           (208,248)
   Increase (decrease) in accounts payable and accrued                                                       
     liabilities ......................................     (1,558,774)        505,248        (193,724)         1,173,433
                                                          ------------    ------------    ------------       ------------
     Net cash flows used in operating activities ......    (20,389,609)     (8,782,377)     (4,903,551)       (42,553,226)
                                                          ------------    ------------    ------------       ------------
INVESTING ACTIVITIES:                                                                                        
   Purchase of equipment and leasehold improvements ...     (2,624,383)       (466,164)       (161,161)        (4,399,800)
   Sale of leasehold improvements .....................      3,000,000              --              --          3,000,000
   Cash paid for deposits .............................         (6,329)        (17,694)             --            (34,767)
                                                          ------------    ------------    ------------       ------------
      Net cash flows provided by (used in)                                                                   
        Investing activities ..........................        369,288        (483,858)       (161,161)        (1,434,567)
                                                          ------------    ------------    ------------       ------------
FINANCING ACTIVITIES:                                                                                        
  Proceeds from issuance of Convertible Preferred                                                            
    Stock, net of related offering costs ..............     21,404,004      16,548,326       3,497,819         47,185,046
  Proceeds from the transaction with  Tseng Labs, Inc.      27,966,372              --              --         27,966,372
  Proceeds from exercise of Series E, F, and G warrants                                                      
    to purchase stock .................................        208,463         472,625              --            681,554
  Decrease in shareholder receivable ..................             --           3,121          20,505             23,626
  Cash received for Common Stock options exercised ....        263,394         111,974          71,312            446,681
  Redemption of Redeemable Preferred Stock ............       (546,051)             --              --           (546,051)
  Proceeds from bridge loan (Note 6) ..................             --              --              --            791,000
  Partner cash contributions ..........................             --              --              --          5,312,355
  Increase in restricted cash .........................       (412,580)         (4,592)       (194,000)          (611,172)
  Principal payments under capital lease obligation ...        (29,214)             --              --            (29,214)
  Proceeds from borrowings ............................             --              --         150,000            150,000
  Repayment of borrowings .............................        (62,502)        (49,175)        (39,000)          (150,000)
                                                          ------------    ------------    ------------       ------------
      Net cash flows provided by financing activities .     48,791,886      17,082,279       3,506,636         81,220,197
                                                          ------------    ------------    ------------       ------------
Net increase (decrease) in cash and cash equivalents ..     28,771,565       7,816,044      (1,558,076)        37,232,404
CASH AND CASH EQUIVALENTS, beginning of
 Period ...............................................      8,460,839         644,795       2,202,871                 --
                                                          ------------    ------------    ------------       ------------
CASH AND CASH EQUIVALENTS, end of period ..............   $ 37,232,404    $  8,460,839    $    644,795       $ 37,232,404
                                                          ============    ============    ============       ============
SUPPLEMENTAL DISCLOSURES OF NONCASH
 FINANCING ACTIVITIES:
Accrual of leasehold improvements payable .............   $         --    $    848,000    $         --       $    848,000
                                                          ============    ============    ============       ============
Accrual of deferred offering costs ....................   $         --    $    441,375    $         --       $    441,375
                                                          ============    ============    ============       ============
Conversion of partners' investment to Preferred Stock .   $         --    $         --    $         --       $  5,312,355
                                                          ============    ============    ============       ============
Conversion of bridge loan to Convertible
   Preferred Stock ....................................   $         --    $         --    $         --       $    791,000
                                                          ============    ============    ============       ============
Conversion of Convertible Preferred Stock for
   Common Stock .......................................   $ 53,766,991    $         --    $         --       $ 53,766,991
                                                          ============    ============    ============       ============
Issuance of Convertible Preferred Stock
 to investment advisors ...............................   $    425,742    $         --    $    115,000       $    540,742
                                                          ============    ============    ============       ============
Issuance of Common Stock as payment of
 Management bonus .....................................   $         --    $         --    $     59,200       $     59,200
                                                          ============    ============    ============       ============
Redemption of Redeemable Preferred Stock for
  Common Stock ........................................   $    545,949    $         --    $         --       $    545,949
                                                          ============    ============    ============       ============
Sale of Common Stock in exchange for
 stock subscription receivable ........................   $         --    $     37,000    $         --       $     37,000
                                                          ============    ============    ============       ============
Sale of Convertible Preferred Stock in exchange for
 stock subscription receivable ........................   $         --    $         --    $         --       $     23,626
                                                          ============    ============    ============       ============
Issuance of Common Stock as payment for
 accounts payable .....................................   $         --    $     37,000    $      4,744       $     48,578
                                                          ============    ============    ============       ============
</TABLE>



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


                                      F-9
<PAGE>   55
                               CELL PATHWAYS, INC.
                          (A DEVELOPMENT STAGE COMPANY)

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998


1.   ORGANIZATION AND BASIS OF PRESENTATION:

     Cell Pathways, Inc. was incorporated in Delaware in July 1998 as a
subsidiary of, and as of November 3, 1998 successor to, a Delaware corporation
of the same name. As the context requires, "Company" is used herein to signify
the successor and/or the predecessor corporations. (See Note 3)

     The Company is a pharmaceutical company focused on the research,
development and future commercialization of products to prevent and treat
cancer. The Company is in the development stage and has not generated any
product revenues to date, nor is there any assurance of any future product
revenues. The Company's intended products are subject to long development cycles
and there is no assurance the Company will be able to successfully develop,
manufacture, obtain regulatory approval for or market its products. During the
period required to develop its products, the Company plans to continue to
finance operations through debt and equity financings, corporate alliances or
through combinations thereof. There is no assurance, however, that such
additional funding will be available on terms acceptable to the Company, if at
all. The Company will continue to be considered in the development stage until
such time as it generates significant revenues from its principal operations. As
of December 31, 1998, the Company had a deficit accumulated during the
development stage of $45,329,772.

     The Company is the successor to Cell Pathways Limited Partnership (the
"Partnership"). The Partnership was formed on August 10, 1990 pursuant to the
laws of the State of Illinois under the name of FGN Pharmaceutical Research
Limited Partnership. The Partnership Agreement was amended on December 9, 1992
to provide for additional financing, admission of a new general partner and new
limited partners, change the name of the Partnership and eventual conversion of
the Partnership to corporate form. On September 29, 1993, the assets and
liabilities of the Partnership were acquired by the Company in exchange for
Preferred and Common Stock of the Company, thereby converting the business from
partnership to corporate form.

     On November 3, 1998, the Company completed a financing through the
acquisition of Tseng Labs, Inc. ("Tseng") (a publicly held shell company) in
which the Company issued to Tseng stockholders approximately 5.5 million shares
of the Company's Common Stock and received net proceeds of approximately $26.4
million (See Note 3). The accompanying financial statements include the accounts
of the Partnership from inception (August 10, 1990) through September 29, 1993,
and the accounts of the Company thereafter (including the accounts of Tseng
after November 3, 1998).

2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

Principles of Consolidation

     The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated.

Management's 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 such estimates.

Cash, Cash Equivalents and Restricted Cash

     For purposes of the statements of cash flows, the Company considers all
highly liquid instruments with an original maturity of three months or less to
be cash equivalents. As of December 31, 1998 and December 31, 1997,
approximately $611,000 and $199,000, respectively, of cash and cash equivalents
were restricted to secure letters of credit for security deposits or
indebtedness of the Company (See Notes 10 and 12).


                                      F-10
<PAGE>   56
Equipment, Furniture and Leasehold Improvements

     Equipment, furniture and leasehold improvements are stated at cost.
Depreciation of equipment and furniture is provided on the straight-line method
over estimated useful lives of three to seven years. Leasehold improvements are
amortized over the shorter of the useful life or the life of the related lease.

Research and Development

     Costs incurred in connection with research and development activities are
expensed as incurred.

Stock Compensation

     The Company accounts for stock option grants in accordance with Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees." Under the Company's stock option plans, options are granted at the
fair market value on the date of the grant and therefore no compensation expense
is recognized for stock options granted to employees. In 1996, the Company
adopted the disclosure provisions of Statement of Financial Accounting Standards
("SFAS") No. 123, "Accounting for Stock-Based Compensation."

Reclassifications

     Certain prior year amounts have been reclassified or reformatted to conform
with the current year presentation.

Basic and Diluted Net Loss Per Common Share

     SFAS No. 128, "Earnings per Share", became effective at the end of 1997 and
requires presentation of two calculations of earnings per common share. "Basic"
earnings per common share equals net income divided by the weighted average
common shares outstanding during the period. "Diluted" earnings per common share
equals net income divided by the sum of the weighted average common shares
outstanding during the period plus common stock equivalents. The Company's basic
and diluted per share amounts are the same since the assumed exercise of stock
options and warrants, conversion of Convertible Preferred Stock, and the
redemption of Redeemable Preferred Stock are all anti-dilutive. The amount of
Common Stock equivalents excluded from the calculation are options and warrants
to purchase 2,128,424, 616,271 and 476,000 shares of Common Stock, Convertible
Preferred Stock convertible into 0, 10,968,387 and 6,227,282 shares of Common
Stock, warrants to purchase 0, 194,395 and 248,823 shares of Convertible
Preferred Stock convertible into the same number of shares of Common Stock and
0, 33,052, and 33,052 shares of Common Stock to be issued upon redemption of the
Redeemable Preferred Stock that were outstanding as of December 31, 1998, 1997
and 1996, respectively.

Recent Accounting Pronouncements

     Effective with the first quarter of 1998, the Company was subject to the
provisions of SFAS No. 130 "Reporting Comprehensive Income." SFAS No. 130 had no
impact on the Company's financial statements as the Company does not have any
"comprehensive income" type earnings (losses).

     In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information", which
established standards for reporting information about operating segments in
annual financial statements. It also established standards for related
disclosures about products and services, geographic areas and major customers.
The Company adopted SFAS No. 131, for its financial statements as of and for the
year ended December 31, 1998. The adoption of SFAS No. 131 did not have an
impact on the Company's results of operations, financial position, cash flows or
disclosures.

     In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities", which
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts
(collectively referred to as derivatives) and for hedging activities. SFAS No.
133 is effective for all fiscal quarters of fiscal years beginning after June
15, 1999. As the Company does not currently engage in derivative or hedging
activities, the Company believes that there will be no impact to the Company's
results of operations, financial position or cash flows upon the adoption of
this standard.


                                      F-11
<PAGE>   57
     In March 1998, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position ("SOP") 98-1, "Accounting for the Cost of
Computer Software Developed or Obtained for Internal Use". SOP 98-1 is effective
for financial statements for years beginning after December 15, 1998. SOP 98-1
provides guidance on accounting for computer software developed or obtained for
internal use including the requirement to capitalize specified costs and
amortization of such costs. The Company does not expect the adoption of this
standard to have a material effect on the Company's capitalization policy.

     In April 1998, the AICPA issued SOP 98-5, "Reporting on the Costs of
Start-Up Activities", which is effective for fiscal years beginning after
December 15, 1998. SOP 98-5 provides guidance on the financial reporting of
start-up costs and organization costs. It requires costs of start-up activities
and organization costs to be expensed as incurred. As the Company has expensed
these costs historically, the adoption of this standard is not expected to have
a significant impact on the Company's results of operations, financial position
or cash flows.

3.   TRANSACTION WITH TSENG:

     In June 1998, Cell Pathways, Inc., a Delaware corporation, and Tseng, a
Utah corporation, entered into an Agreement and plan of reorganization (the
"Reorganization Agreement"). The Reorganization Agreement provided for (i) the
formation of Cell Pathways Holding, Inc., a Delaware corporation ("CPHI"), (ii)
the merger of Tseng Sub, Inc., a wholly-owned subsidiary of CPHI, with and into
Tseng, (iii) the merger of CPI Sub, Inc., a wholly owned subsidiary of CPHI,
with and into Cell Pathways, Inc. and (iv) the issuance of approximately 23% of
the outstanding shares of the Common Stock of CPHI to the Tseng stockholders and
approximately 77% of the outstanding shares of the Common Stock of CPHI to the
Cell Pathways, Inc. stockholders. In connection with this transaction the
Company raised net proceeds of aproximately $26.4 million (see Note 1). As a
result of the aforementioned transactions, Tseng and Cell Pathways, Inc.,
subsequently renamed Cell Pathways Pharmaceuticals, Inc. ("CPP") became
wholly-owned subsidiaries of CPHI, subsequently renamed Cell Pathways, Inc.
("CPI"). The transaction closed November 3, 1998 and was accounted for as a
reorganization of CPP into CPI with the sale of approximately 23% of CPI Common
Stock in exchange for Tseng's net assets. The historical financial statements of
the combined Company are the historical financial statements of CPP.

4.   EQUIPMENT, FURNITURE AND LEASEHOLD IMPROVEMENTS:

     Equipment, furniture and leasehold improvements consisted of the following:

<TABLE>
<CAPTION>
                                                                       DECEMBER 31,
                                                               --------------------------
                                                                   1998           1997
                                                               -----------    -----------

<S>                                                            <C>            <C>        
              Furniture and fixtures .......................   $   257,412    $    56,808
              Computer equipment and software ..............       652,031        265,823
              Laboratory equipment .........................     1,012,208        194,893
              Leasehold improvements .......................            --      1,257,893
                                                               -----------    -----------
                                                               $ 1,921,651    $ 1,775,417
              Less accumulated depreciation and amortization      (388,017)      (132,820)
                                                               -----------    -----------
                                                               $ 1,533,634    $ 1,642,597
                                                               ===========    ===========
</TABLE>


     In June 1998, the Company entered into a new facility lease (see Note 12)
in which the company received a one-time payment of $3.0 million of which, to
date, approximately $2.8 million relates to the reimbursement of leasehold
improvements made by the Company to the facility. The leasehold improvements
that were included in equipment, furniture and leasehold improvements in the
accompanying consolidated balance sheets were removed from the Company's assets
as they became the property of the new lessor. No gain or loss was recorded on
the transaction as the reimbursement was at the net book value of the assets. As
of December 31, 1998, the Company has approximately $161,000 accrued on the
accompanying balance sheet related to remaining payments on leasehold
improvements that will become the property of the new lessor once purchased.


                                      F-12
<PAGE>   58
5.   OTHER ACCRUED LIABILITIES:

Other accrued liabilities consisted of the following:

<TABLE>
<CAPTION>
                                                      DECEMBER 31,
                                                -----------------------
                                                   1998         1997
                                                ----------   ----------
<S>                                             <C>          <C>       

                   Accrued severance ........   $  339,638   $       --
                   Accrued research contracts      681,790    1,056,855
                   Other ....................      762,952      260,950
                                                ----------   ----------
                                                $1,784,380   $1,317,805
                                                ==========   ==========
</TABLE>

6.   STOCKHOLDERS' EQUITY:

     As of December 31, 1998, the Company was authorized to issue a total of
75,000,000 shares of stock, consisting of 5,000,000 shares of $0.01 par value
Preferred Stock, and 70,000,000 shares of $0.01 par value Common Stock. As of
December 31, 1997, the Company was authorized to issue a total of 30,061,250
shares of stock, consisting of 13,000,000 shares of $0.01 par value Preferred
Stock, 61,250 shares of $0.01 par value Redeemable Preferred Stock and
17,000,000 shares of $0.01 par value Common Stock. At December 31, 1997 the
Company had the following Convertible Preferred Stock outstanding:

<TABLE>
<S>                                                                           <C>        
              Series A, 872,400 shares authorized, issued and
                outstanding, entitled to a preference in liquidation of
                $1,011,984 ................................................   $   812,000
              Series B, 848,100 shares authorized, issued and
                outstanding, entitled to a preference in liquidation of
                $1,051,675 ................................................       868,000
              Series C, 700,000 shares authorized, issued and
                outstanding, entitled to a preference in liquidation of
                $1,540,000 ................................................     1,540,000
              Series D, 675,350 shares authorized, 616,808 shares issued
                and outstanding, entitled to a preference in liquidation of
                $1,860,042 ................................................     1,860,042
              Series E, 3,204,865 shares authorized, 3,121,642 shares
                issued and outstanding, entitled to a preference in
                liquidation of  $9,833,172 ................................     9,528,279
              Series F, 4,934,788 shares authorized, 4,809,437 shares
                issued and outstanding, entitled to a preference in
                liquidation of $17,794,917 ................................    17,549,679
              Series G, 4,873,672 shares authorized in 1998 ...............            --
                                                                              -----------
                                                                              $32,158,000
                                                                              ===========
</TABLE>

     In conjunction with the transaction with Tseng, each share of Series A, B,
C, D, E, F and G Convertible Preferred Stock was converted into one share of CPI
Common Stock.

     Series A, B, C and D Convertible Preferred shares corresponded to similarly
designated classes of limited partnership units issued by the Partnership
pursuant to financings arranged in 1990 (Class A), 1991 (Class B) and 1992
(Classes C and D) which resulted in net proceeds to the Company of $812,000,
$1,051,675, $1,540,000 and $1,860,042, respectively.

     In April 1994, the Company issued 542,761 Series E Convertible Preferred
shares ("Series E"), and warrants to purchase an additional 18,766 shares of
Series E at $4.10 per share resulting in net proceeds to the Company of
approximately $2,225,000. In conjunction with the Company's 1995 financing (see
below), the Series E was re-priced to $3.15 per share, the same price as the
1995 financing. Accordingly, the Company issued an additional 163,701 shares of
Series E and warrants to purchase an additional 5,654 shares of Series E at
$3.15 per share. In March 1994, the Company issued 16,667 shares of Common Stock
as partial payment for financial advisory services.


                                      F-13
<PAGE>   59
     In June through August 1995, the Company borrowed $791,000 from certain of
its stockholders. In August 1995, this bridge loan, together with interest at
9%, was converted into 253,633 shares of Series E at $3.15 per share. In
connection with the bridge loan, warrants to purchase 125,550 shares of Series E
at $3.15 per share were issued. In August 1995, the Board of Directors
authorized the issuance and sale of up to $7 million of Series E at $3.15 per
share, including conversion of the bridge loan. During the year ended December
31, 1995, the Company issued 1,121,800 shares of Series E and warrants to
purchase 85,339 shares of Series E at $3.15 per share, resulting in net proceeds
to the Company of approximately $3,534,000; and in January through May of 1996,
the Company issued 841,306 shares of Series E at $3.15 per share, resulting in
net proceeds to the Company of approximately $2,650,000. This offering,
including conversion of the bridge loan, resulted in the issuance of 2,216,739
shares of Series E and warrants to purchase 210,889 shares of Series E ,
resulting in net proceeds of approximately $6,832,000. In May of 1996, the
Company issued 46,355 shares of Series E and $154,000 cash as payment for
financial advisory services.

     During 1996, the Company issued 185,000 shares of Common Stock as bonuses
to officers and employees, and 14,828 shares of Common Stock were issued for
consulting services.

     In December 1996, the Company issued 270,270 shares of Series F Convertible
Preferred Stock ("Series F") and warrants to purchase 13,514 shares of Series F
at $3.70 per share, resulting in net proceeds to the Company of $1,000,000.
During 1997, the Company issued 4,507,594 shares of Series F and warrants to
purchase 112,329 shares of Series F, resulting in net proceeds to the Company of
approximately $16,548,000. The warrants are exercisable until the earlier of
July 20, 1999, or the sale of all or substantially all of the assets of the
Company. In addition, the Company issued 31,081 shares of Series F as
compensation for services rendered in connection with the offering of the Series
F.

     In April through June 1998, the Company issued 4,556,249 shares of Series G
Convertible Preferred Stock ("Series G") and warrants to purchase 227,793 shares
of Series G at $4.75 per share, resulting in net proceeds to the Company of
approximately $21,404,000. The warrants are exercisable until the earlier of May
1, 2000, or the sale of substantially all of the assets of the Company. In
addition, the Company issued 89,630 shares of Series G as compensation for
services rendered in connection with the offering of the Series G.

7.   REDEEMABLE PREFERRED STOCK:

     Prior to redemption, the Redeemable Preferred Stock carried no vote and no
dividend and was mandatorily redeemable in an aggregate amount of $1,092,000 in
cash and/or freely transferable Common Stock upon the closing of any firm
commitment underwritten public offering of Common Stock. In November 1998,
immediately prior to the transaction with Tseng, the Company redeemed the
Redeemable Preferred Stock for $546,051 and 33,052 shares of Common Stock. The
Company recorded a provision for the redemption of the Redeemable Preferred
Stock during the third quarter of 1997 as Company preparations for an initial
public offering of Common Stock made it probable that the Company would redeem
the Redeemable Preferred Stock.

8.   STOCKHOLDERS' RIGHTS PLAN:

     On December 3, 1998, the Company's Board of Directors authorized the
adoption of a stockholders' rights plan. Under the plan, rights to purchase
stock, at a rate of one right for each share of Common Stock held, were
distributed to holders of record on December 15, 1998 and automatically attach
to shares issued thereafter. Under the plan, the rights attach to the Common
Stock and are not represented by separate rights certificates until, and
generally become exercisable only after, a person or group (i) acquires 15% or
more of the Company's outstanding Common Stock or (ii) commences a tender offer
that would result in such a person or group owning 15% or more of the Company's
Common Stock. When the rights first become exercisable, a holder will be
entitled to buy from the Company a unit consisting of one one-hundredth of a
share of Series A Junior Participating Preferred Stock of the Company at a
purchase price of $90. However, if any person acquires 15% or more of the
Company's Common Stock other than pursuant to a qualified offer, each right not
owned by a 15% or more stockholder would become exercisable for Common Stock of
the Company (or in certain circumstances, other consideration) having a market
value equal to twice the exercise price of the right. The rights expire on
December 14, 2008, except as otherwise provided in the plan. Full details are
set forth in the rights agreement filed as an exhibit to the Company's Report on
Form 8-K dated December 18, 1998.


                                      F-14
<PAGE>   60
9.   STOCK OPTIONS AND WARRANTS:

     The Company's 1993 Stock Option Plan, which was amended and renamed in 1997
the 1997 Equity Incentive Plan (the "Plan"), authorizes the Company to grant to
eligible employees, directors and consultants Common Stock, stock appreciation
rights, or options to purchase Common Stock with respect to 2,350,000 shares of
Common Stock. As of December 31, 1998, options with respect to 1,756,571 shares
have been granted, 509,600 have been exercised, 85,500 have been forfeited,
1,161,471 were outstanding, and 678,929 shares of Common Stock remained eligible
for future option grants. The stock options granted may be either incentive
stock options ("ISO") or nonstatutory stock options ("NSO"). Such options may be
granted only at an exercise price equal to the fair market value of the shares
at the date of grant unless such option is granted pursuant to an assumption of
or a substitution for another option. The Board of Directors may set the rate at
which the options become exercisable and determine when the options expire,
subject to the limitations described below. The options granted may be exercised
up to ten years following the date of grant. All options will generally become
exercisable in the event the Company is sold or has other significant changes in
ownership. Generally, options to employees vest ratably over a four-year period.
Options granted under the Plan through July 1997 may be immediately exercisable,
but any unvested shares exercised are held by the Company and are subject to
reacquisition by the Company should employment terminate prior to completion of
applicable vesting periods.

     In 1995, the Company adopted the 1995 Cell Pathways, Inc. Stock Award Plan
pursuant to which the Company may award shares of Common Stock to employees,
directors and consultants as part or all of their compensation, whether salary,
bonus or fee and whether for past services or as incentive for current and
future services. The only awards which have been made under this plan were made
during 1996 by way of bonus compensation to officers and employees of the
Company for the years 1993, 1994 and 1995. In accordance with APB Opinion No.
25, a compensation charge of $59,000 associated with the issuance of 185,000
shares of Common Stock having a fair market value of $0.32 per share at the date
of grant, was recognized in the year ended 1995.

     In October, 1997, the Board of Directors adopted and the stockholders
approved the 1997 Non-Employee Directors' Stock Option Plan (the "Directors'
Plan") covering an aggregate of 453,925 shares of Common Stock. Pursuant to the
terms of the Directors' Plan, each person who first becomes a non-employee
Director automatically shall be granted an option to purchase 18,157 shares of
Common Stock (the "Inaugural Grant"). On the date of each annual stockholders
meeting commencing with the meeting in 1998, each non-employee Director who has
served at least one full year as a director is automatically granted an option
to purchase 5,447 shares of Common Stock (the "Anniversary Grant"). In addition,
the Company granted options to purchase 27,235 shares of Common Stock at the
inception of the plan. Options subject to an Inaugural Grant under the
Directors' Plan will vest in three equal, annual installments commencing on the
first anniversary of the date of the grant of the option. Options subject to an
Anniversary Grant under the Directors' Plan will vest in full on the first
anniversary of the date of the grant of the option. In addition, certain grants
made at the inception of the Director's Plan vested on March 31, 1998. The
vesting of all options under the Directors' Plan is conditioned on the continued
service of the recipient as a director, employee or consultant of the Company or
any affiliate of the Company. As of December 31, 1998, options to purchase
127,098 shares of Common Stock have been granted, none have been exercised or
forfeited.

     The exercise price of the options granted under the Directors' Plan will be
equal to the fair market value of the Common Stock granted on the date of grant.
No option granted under the Directors' Plan may be exercised after the
expiration of ten years from the date it was granted. Options granted under the
Directors' Plan generally are non-transferable, except as provided in the option
agreement. The Directors' Plan will terminate on the tenth anniversary of the
date of its adoption by the Board unless sooner terminated by the Board. In the
event of certain changes of control, options outstanding under the Directors'
Plan will automatically become fully vested and will terminate if not exercised
prior to such change of control.

     In November 1998, the Company assumed the Tseng Labs, Inc. 1991 Stock
Option Plan, the Tseng Labs, Inc. 1991 Special Directors Stock Option Plan and
the Tseng Labs, Inc. 1995 Stock Option Plan. The Company assumed the plans in
order to administer the remaining options outstanding as of November 4, 1998.
The Company has no intention of issuing any options under these plans and
subsequent to year end has taken action to terminate any right to grant further
options under the assumed stock option plans. As of December 31, 1998, there are
482,476 options outstanding under these plans to purchase Common Stock at a
weighted average exercise price of $8.10 per share.


                                      F-15
<PAGE>   61
     The Company accounts for stock options granted to employees under the Plan
in accordance with the intrinsic value method provided for under APB Opinion No.
25. Under the Plan, options may be granted at the fair market value on the date
of the grant and therefore no compensation expense is, or has been, recognized
in respect of stock options awarded to employees. The option pricing models
recommended by SFAS No. 123 for recognition of, or disclosure of pro forma
compensation cost in respect of employee stock options are option pricing models
which have been developed for fully transferable, traded options having no
vesting requirements and which require the input of subjective assumptions
including expected stock price volatility. Because the Company's employee stock
options have characteristics significantly different from those of traded
options, in management's opinion, the existing models do not necessarily provide
a reliable single measure of the fair value of its stock options. Had
compensation cost for the Plan been recognized in the income statements under
SFAS No. 123, the Company's net loss would have increased to the following pro
forma amounts:

<TABLE>
<CAPTION>
                                                         YEAR ENDED DECEMBER 31,
                                           ---------------------------------------------------
                                                1998              1997              1996
                                           --------------    --------------    -------------- 
<S>                                        <C>               <C>               <C>            
              Net loss:
                As reported ............   $  (19,345,436)   $  (10,296,912)   $   (4,735,204)
                                           ==============    ==============    ============== 
                Pro forma ..............   $  (19,643,828)   $  (10,369,323)   $   (4,737,081)
                                           ==============    ==============    ============== 
              Basic and diluted
              net loss per Common Share:
                As reported ............   $        (3.04)   $        (3.63)   $        (1.83)
                                           ==============    ==============    ============== 
                Pro forma ..............   $        (3.08)   $        (3.65)   $        (1.83)
                                           ==============    ==============    ============== 
</TABLE>


The pro forma disclosures made above do not reflect options granted prior to
January 1, 1995. Therefore this pro forma compensation cost may not be
representative of the effects which SFAS No. 123 may have on the disclosure of
pro forma compensation cost in future years. The weighted average fair value of
the stock options granted during 1998, 1997, and 1996 was $1.93, $0.92 and
$0.10, respectively. The fair value of each option grant is estimated on the
date of grant using the Black-Scholes option pricing model with the following
weighted average assumptions:

<TABLE>
<CAPTION>
                                                1998      1997      1996
                                               ------    ------    ------
<S>                                            <C>       <C>       <C>  
                   Risk-free interest rate     6.15%     6.15%     6.15%
                   Expected dividend yield       0%        0%        0%
                   Expected life.........     6 years   6 years   6 years
                   Expected volatility...       .45%       0%        0%
</TABLE>


Information relative to the Company's stock options is as follows:

<TABLE>
<CAPTION>
                                                                          WEIGHTED
                                                                          AVERAGE
                                                      EXERCISE PRICE   EXERCISE PRICE    AGGREGATE
                                          OPTIONS       (PER SHARE)     (PER SHARE)       PROCEEDS
                                       ------------   --------------   --------------   ------------

<S>                                    <C>            <C>              <C>              <C>         
     Balance as of December 31, 1995        186,850    $        0.32        $0.32       $     59,792
       Granted .....................        522,500      0.32 - 0.50         0.38            198,700
       Exercised ...................       (222,850)            0.32         0.32            (71,313)
       Forfeited ...................        (10,500)            0.32         0.32             (3,360)
                                       ------------    -------------        -----       ------------
     Balance as of December 31, 1996        476,000     0.32 - 0.50          0.39            183,819
       Granted .....................        455,021     1.00 - 4.75          3.47          1,578,000
       Exercised ...................       (251,250)    0.32 - 0.50          0.45           (111,974)
       Forfeited ...................        (63,500)    0.32 - 3.70          0.85            (54,120)
                                       ------------    -------------        -----       ------------
     Balance as of December 31, 1997        616,271     0.32 - 3.70          2.59          1,595,725
       Granted .....................        719,298     4.75 -12.13          6.39          4,599,069
       Tseng options assumed .......        512,476     3.79 -24.10          8.10          4,151,701
       Exercised ...................        (65,500)    0.32 - 8.09          4.02           (263,394)
       Forfeited ...................        (11,500)    0.32 - 6.60          0.39             (4,525)
                                       ------------    -------------        -----       ------------
     Balance as of December 31, 1998      1,771,045    $0.32-$24.10         $5.69       $ 10,078,576
                                       ============    =============        =====       ============
     Options exercisable as of
     December 31, 1998 .............        767,705                         $6.19
                                       ============                         =====
</TABLE>


The weighted average remaining contractual life of all options outstanding at
December 31, 1998 is 8.2 years.


                                      F-16
<PAGE>   62
The following table summarizes information about the Company's stock options
outstanding and exercisable at December 31, 1998 based upon each exercise price:

<TABLE>
<CAPTION>
                                        OPTIONS OUTSTANDING                     OPTIONS EXERCISABLE
                         ----------------------------------------------   -------------------------------
                            NUMBER OF         WEIGHTED      WEIGHTED                           WEIGHTED
                             OPTIONS          AVERAGE        AVERAGE          NUMBER           AVERAGE
           RANGE OF        OUTSTANDING       REMAINING      EXERCISE       EXERCISABLE        EXERCISE
           EXERCISE       AT DECEMBER 31,   CONTRACTUAL       PRICE       AT DECEMBER 31,       PRICE
            PRICES             1998        LIFE IN YEARS   (PER SHARE)         1998          (PER SHARE)
          ----------     ---------------   -------------  -------------   ---------------   -------------
<S>                      <C>               <C>            <C>             <C>               <C>    
        $ 0.32-$0.50          131,250           6.9         $  0.38            88,332         $  0.32
                1.00           80,000           8.2            1.00            20,000            1.00
                3.70          240,000           8.6            3.70            84,539            3.70
                3.79           70,813           9.0            3.79            70,813            3.79
                4.13            7,263           9.1            4.13             7,263            4.13
                4.75          213,413           9.1            4.75            70,358            4.75
                6.60          618,806           9.5            6.60            22,000            6.60
                8.09          368,266           6.1            8.09           368,266            8.09
                9.29            7,263           8.6            9.29             7,263            9.29
               11.36            7,263           8.0           11.36             7,263           11.36
               12.13            5,100          10.0           12.13                --           12.13
               21.69           16,341           6.9           21.69            16,341           21.69
               24.10            5,267           7.6           24.10             5,267           24.10
                           ----------                                       ---------
                            1,771,045                                         767,705
                           ==========                                       =========
</TABLE>

     In October 1997, the Board of Directors adopted and the stockholders
approved the Employee Stock Purchase Plan (the "Purchase Plan") covering an
aggregate of 544,710 shares of Common Stock. Under the Purchase Plan, the Board
may authorize participation by eligible employees, including officers, in
periodic offerings following the adoption of the Purchase Plan. The offering
period for any offering will be no longer than 27 months.

     As of November 4, 1988, employees became eligible to participate in the
Purchase Plan if they are employed by the Company or an affiliate of the Company
designated by the Board. Employees who participate in an offering can have up to
15% of their earnings withheld pursuant to the Purchase Plan and applied, on
specified dates determined by the Board, to the purchase of shares of Common
Stock. The price of Common Stock purchased under the Purchase Plan will be not
less than 85% of the lower of the fair market value of the Common Stock on the
commencement date of each offering period or the relevant purchase date.
Employees may end their participation in the offering at any time during the
offering period, and participation ends automatically on termination of
employment with the Company. The Purchase Plan will terminate at the Board's
direction.

     In 1994 and 1995, the Company issued warrants to purchase an aggregate of
235,309 shares of Series E at an exercise price of $3.15 per share. All
unexercised warrants to purchase Series E expired upon consummation of the
transaction with Tseng.

     In 1996, the Company issued warrants to purchase 13,514 shares of Series F
and during 1997, warrants to purchase 112,329 shares of Series F at an exercise
price of $3.70 per share, all exercisable until the earlier of: (i) July 20,
1999; and (ii) the sale of all or substantially all of the assets of the
Company. As a result of the transaction with Tseng in November 1998, the
warrants no longer purchase shares of Series F. The warrants purchase the
equivalent number of shares of Common Stock at an exercise price of $3.70 per
share. As of December 31, 1998, warrants to purchase 125,201 shares of Common
Stock were outstanding.

     In 1998, the Company issued warrants to purchase 227,793 shares of Series G
at an exercise price of $4.75 per share. As a result of the transaction with
Tseng in November 1998, the warrants no longer purchase shares of Series G. The
warrants purchase the equivalent number of shares of Common Stock at an exercise
price of $4.75 per share. As of December 31, 1998, warrants to purchase 227,178
shares of Common Stock were outstanding.

     In 1998 the Company issued warrants to purchase 5,000 shares of Common
Stock at an exercise price of $6.60 per share to an investment advisor in
consideration for services rendered. These warrants are exercisable through June
30, 2000.


                                      F-17
<PAGE>   63
10.  DEBT:

     In March 1996, the Company borrowed $150,000 from a bank. The note bore
interest at a rate of 7.79% and was payable in equal monthly installments
through March 1999. During the year ended December 31, 1998, the note was
repaid.

11.  INCOME TAXES:

     The Company accounts for income taxes under the provisions of SFAS No. 109,
"Accounting for Income Taxes." As of December 31, 1998, the Company had
approximately $13,625,000 of net operating loss carryforwards ("NOLs") for
income tax purposes available to offset future federal income tax, subject to
limitations for alternative minimum tax. The NOLs are subject to examination by
the tax authorities and expire between 2008 and 2019.

     Prior to its conversion into corporate form, the business had accumulated
losses totaling approximately $3,900,000. For tax purposes these losses were
distributed to the partners in accordance with the provisions of the Partnership
Agreement of the Company's predecessor partnership. Thus, these losses, while
included in the financial statements of the Company, are not available to offset
future taxable income, if any, of the Company.

     The Tax Reform Act of 1986 contains provisions that may limit the NOLs
available to be used in any given year upon the occurrence of certain events,
including significant changes in ownership interest. A change in ownership of a
company of greater than 50% within a three-year period results in an annual
limitation on the Company's ability to utilize its NOLs from tax periods prior
to the ownership change. The Company believes that the transaction with Tseng
(see Note 3) triggered such limitation. However, the Company does not expect
such limitation to have a significant impact on its operations.

     The components of the net deferred income tax asset at December 31, 1998
and 1997 were as follows:

<TABLE>
<CAPTION>
                                                               DECEMBER 31,
                                                       --------------------------
                                                           1998           1997
                                                       -----------    -----------
<S>                                                      <C>          <C>        
                   Net operating loss carryforwards      5,293,000    $ 4,777,000
                   Capitalized research and
                     development expenditures ......     8,695,000      3,194,000
                   Capitalized start-up costs ......     2,521,000        797,000
                   Accruals not currently deductible       216,000             --
                                                       -----------    -----------
                                                        16,725,000      8,768,000
                                                       -----------    -----------
                   Less valuation allowance ........   (16,725,000)    (8,768,000)
                                                       -----------    -----------
                                                       $      --      $      --
                                                       ===========    ===========
</TABLE>


     The Company has not yet achieved profitable operations. Accordingly,
management believes the tax assets as of December 31, 1998 do not satisfy the
realization criteria set forth in SFAS No. 109 and has recorded a valuation
allowance for the entire net tax asset.

12.  COMMITMENTS AND CONTINGENCIES:

Leases

     In June 1998, the Company entered into a ten-year lease for office and
laboratory space in Horsham, Pennsylvania. This lease contains two five-year
renewal terms. The Company also has a lease for office and laboratory space in
Aurora, Colorado which expires in June 1999. In 1998 the Company consolidated
its operations in its new facility in Horsham, Pennsylvania. The Company has
provided for the cost of the 1999 remaining rent payments for the Aurora space
in 1998.

     In 1998, the Company also entered into a 30-month capital lease agreement
to lease software to be used in the research and development activities of the
Company. The software acquired under the lease at a cost of $335,371 less
accumulated amortization of $55,895 is included in equipment in the accompanying
consolidated balance sheet as of December 31, 1998. The interest rate on this
capital lease is 12%.


                                      F-18
<PAGE>   64
     Aggregate minimum annual payments under the Company's lease commitments are
as follows as of December 31, 1998:

<TABLE>
<CAPTION>
                                                                  CAPITAL      OPERATING
                                                                   LEASE         LEASES
                                                                 ----------    ----------

<S>                <C>                                           <C>           <C>       
                   1999 ......................................   $  156,000    $  831,000
                   2000 ......................................      156,000       856,000
                   2001 ......................................       36,000       882,000
                   2002 ......................................           --       908,000
                   2003 ......................................           --       936,000
                   thereafter ................................           --     4,566,000
                                                                 ----------    ----------
                   Total minimum lease payments ..............      348,000    $8,979,000
                                                                 ----------    ----------
                   Less: Interest ............................      (42,000)
                                                                 ----------
                   Present value of net minimum lease payments   $  306,000
                                                                 ==========
</TABLE>

     Rental expense under the operating leases and other month-to-month leases
entered into by the Company totaled approximately $815,000, $121,000 and $95,000
for the years ended December 31, 1998, 1997 and 1996, respectively.

Contracts

     The Company contracts with a number of university-based researchers and
commercial vendors who provide various research, clinical and product
development activities. Such arrangements are generally cancelable at any time.

     At December 31, 1998 the Company had contracted with a manufacturer to
purchase approximately 1,000 kilos of raw materials worth approximately
$800,000.

Litigation

     In February and March 1999, five purported stockholder class action
complaints were filed against the Company and certain of its officers and
directors in the United States District Court for the Eastern District of
Pennsylvania alleging that the Company had made false and misleading statements
about the efficacy and near-term commercialization of the Company's lead drug
candidate. The complaints seek unspecified damages on behalf of purported
classes of persons including former Tseng stockholders and persons who purchased
Company Common Stock from November 3 or November 11, 1998 through February 2,
1999, inclusive. The Company believes that the allegations of the complaints are
without merit and intends to vigorously contest the litigations.



                                      F-19