<PAGE>   1


                       SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C.  20549

                                   FORM 10-K
   (Mark One)
   [ X ]     Annual report pursuant to section 13 or 15(d) of the Securities
             Exchange Act of 1934 
             For the fiscal year ended DECEMBER 31, 1997
                                       -----------------
                                       OR
   [   ]     Transition report pursuant to section 13 or 15(d) of the
             Securities Exchange Act of 1934 
             For the transition period from               to
                                           ---------------  -----------------

                         Commission File Number 0-19651
                                                -------

                         MAGAININ PHARMACEUTICALS INC.
            -------------------------------------------------------
            (Exact name of registrant as specified in its charter.)

          Delaware                                         13-3445668
-------------------------------                            ----------
(State or other jurisdiction of                            (IRS Employer
incorporation or organization)                             Identification No.)

5110 Campus Drive, Plymouth Meeting, PA                    19462
---------------------------------------                    -----
(Address of principal executive offices)                   (Zip Code)

       Registrant's telephone number, including area code: (610) 941-4020
                                                           --------------

          SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

       None                                              N/A
-----------------                    -------------------------------------------
(Title of each class)                (Name of each exchange on which registered)

          SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

                    Common Stock, $.002 par value per share
                    ---------------------------------------
                                (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 Regulations S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. [  X  ]

The aggregate market value of the voting stock held by non-affiliates of the
registrant is approximately $158,602,000.  Such aggregate market value was
computed by reference to the closing price of the Common Stock as reported on
the National Market System of The Nasdaq Stock Market, on March 5, 1998.  For
purposes of this calculation only, the registrant has defined affiliates as
including all directors and executive officers.  The number of shares of the
registrant's Common Stock outstanding as of March 5, 1998 was 22,105,130.

                      DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Definitive Proxy Statement for the Registrant's 1998 Annual
Meeting of Stockholders to be filed within 120 days after the end of the fiscal
year covered by this Annual Report on Form 10-K are incorporated by reference
into Part III of this Form 10-K.
<PAGE>   2
                         MAGAININ PHARMACEUTICALS INC.
                               INDEX TO FORM 10-K

<TABLE>
<CAPTION>
                                                DESCRIPTION                                 PAGE NO
                                                -----------                                 -------
        <S>      <C>                                                                        <C>
                 PART I
         ITEM 1  BUSINESS                                                                       1  

         ITEM 2  PROPERTIES                                                                    24

         ITEM 3  LEGAL PROCEEDINGS                                                             24

         ITEM 4  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                           24


                 PART II
         ITEM 5  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER                 24
                 MATTERS

         ITEM 6  SELECTED FINANCIAL DATA                                                       26

         ITEM 7  MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
                 FINANCIAL CONDITION                                                           27

         ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK                     31
         
         ITEM 8  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                   31

         ITEM 9  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
                 FINANCIAL DISCLOSURE                                                          31


                 PART III
        ITEM 10  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT                            32

        ITEM 11  EXECUTIVE COMPENSATION                                                        32

        ITEM 12  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT                32

        ITEM 13  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                                32


                 PART IV
        ITEM 14  EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K               32

                 INDEX TO FINANCIAL STATEMENTS                                                F-1
</TABLE>
<PAGE>   3
ITEM 1           BUSINESS

GENERAL

         Magainin Pharmaceuticals Inc. ("Magainin" or the "Company") is a
biopharmaceutical company engaged in the development of medicines for serious
diseases.  The Company's development efforts are focused on anti-infectives,
oncology, and pulmonary and allergic disorders.

         Magainin's research and drug development efforts are focused on two
technology platforms:

     -   Host Defense Drug Discovery--the Company isolates and develops
         therapeutically active compounds from the host defense systems of
         animals. Magainin peptides represent a new class of antibiotics being
         developed for the treatment of infection.  The Company's second host
         defense class, aminosterols, is a new class of pharmaceuticals which
         the Company believes may have multiple applications, including the
         control of cell proliferation.

     -   Asthma Genomics--the Company employs a broad range of genomics
         techniques to identify genes associated with the pathogenesis of
         asthma, with the objective of utilizing the optimal biologic gene
         targets in the development of novel therapeutics for asthma and
         allergy.


         Magainin Peptides--Cytolex(TM)

         The Company's most advanced class of compounds under development are
magainin peptides. Discovered in the skin of the African clawed frog, magainins
have demonstrated broad activity against a variety of pathogens in preclinical
studies. These molecules act by puncturing the membrane of the pathogen cell,
resulting in the death of the pathogen.

         The Company's lead product development candidate is Cytolex(TM)
(formerly called MSI-78), a topical cream antibiotic. The Company has completed
two pivotal Phase III clinical trials of Cytolex for the treatment of infection
in diabetic foot ulcers. These studies were designed as equivalence trials, with
the goal of demonstrating that topically applied Cytolex is as effective as
orally administered ofloxacin, a quinolone antibiotic indicated for the
treatment of infection, including skin and soft tissue infections.  The Company
intends to submit a New Drug Application ("NDA") to the U.S. Food and Drug
Administration (the "FDA") based on the results of these trials early in the
second half of 1998. See Item 1 -- Risk Factors: "Risks Associated with Clinical
Testing and FDA Approval of Cytolex."

         In February 1997, the Company and SmithKline Beecham ("SB") entered
into a development, supply and distribution agreement pursuant to which SB will
market and sell Cytolex in North America. Under this agreement, SB has paid $10
million to the Company, and may make additional payments of up to $22.5 million
upon the occurrence of certain product milestones. SB will also fund a majority
of development expenses for any additional indications for Cytolex.

         Cytolex(TM) is a registered trademark of the Company.  All other
brand names or trademarks appearing herein are the property of their respective
holders.

         Aminosterols--Squalamine

         Squalamine is the lead product development candidate in the Company's
aminosterol program. Squalamine was discovered in the body tissues of the
dogfish shark. The shark was initially examined because of its known resistance
to infection and cancer. Since the discovery of squalamine, the Company has
discovered several other aminosterol compounds in the shark. In preclinical
testing conducted to date, certain of these compounds have demonstrated an
ability to control cell growth, along with other pharmacological properties.
These properties may have application in the treatment of disease indications
characterized by cell proliferation, such as cancer.

         The Company's initial disease focus for squalamine is solid tumors.
The formation of new blood vessels, or angiogenesis, is believed to be a
critical factor in tumor growth. Squalamine may be of benefit in the





                                       1

<PAGE>   4
treatment of a number of solid tumors by inhibition of new blood vessel growth
required for tumor nourishment.

         The Company is currently conducting Phase I clinical testing of
squalamine in patients with advanced malignancy.

         Asthma Genomics

         In 1996, the Company initiated a research program in the genomics of
asthma. These efforts led to the identification of AAF1, a gene which varies in
DNA structure and function in asthmatic and allergic humans and animals. The
Company maintains a comprehensive research and development program to identify
additional genes in the AAF1 biologic pathway, which genes are believed to be
important in mediating the allergic responses controlled by AAF1. AAF2 has been
discovered in humans as a key second gene candidate in the AAF1 pathway, and
other genes have also been identified by the Company. The Company continues to
investigate the role of such genes in the allergic inflammatory response.




         Since commencing operations, the Company has not generated any
sales revenue.  The Company has funded operations primarily from the proceeds
of public and private placements of securities.  The Company has incurred
losses in each year since its inception, and expects to incur substantial
additional losses for the next several years.  The Company currently has no
marketable products, and it may be several years, if ever, until marketable
products are developed and approved.







                                       2

<PAGE>   5
RISK FACTORS

         The Company's business is subject to a number of risks and
uncertainties.  In addition to the other information contained in this Annual
Report on Form 10-K, the following risk factors should be carefully considered.

         Risks Associated with Clinical Testing and FDA Approval of Cytolex. The
Company has completed two pivotal Phase III clinical trials of Cytolex for the
treatment of infection in diabetic foot ulcers and intends to submit an NDA to
the FDA based on the results of these trials early in the second half of 1998.
Although the Company believes the two pivotal trials conducted for Cytolex
yielded successful results, there can be no assurance that the FDA will concur
with the Company's analysis in this regard.

         The clinical trials conducted for Cytolex yielded substantial data
including data relating to clinical cure or improvement of infection, and data
relating to overall microbiological results. The Company's data package will
include extensive additional data, including clinical data on key patient
cohorts (subgroups), and microbiology data for specific pathogens. Certain of
the data favor ofloxacin. Additionally, the Company is continuing its analyses
of data from the studies.


         There can be no assurance that Cytolex will receive FDA approval on a
timely basis, if at all. The guidelines pursuant to which clinical trials of
this nature are to be conducted have evolved since the commencement of these
studies by the Company. There can be no assurance that the FDA will not, after
completing its own analysis of the two pivotal trials conducted for Cytolex,
determine that such trials should have been conducted or analyzed differently,
and thus reach a different conclusion from that reached by the Company or
request that further studies be conducted. Conducting additional studies would
likely be time consuming and expensive. The failure of the Company to obtain FDA
approval for Cytolex, any significant delay in obtaining such approval, or the
imposition of highly restrictive conditions on such approval, would have a
material adverse effect on the Company.

         Accumulated Deficit; Continuing Losses.   The Company has been engaged
to date primarily in research and development activities and, through December
31, 1997, has generated no revenue from product sales. The Company has incurred
losses in each year since its inception, and at December 31, 1997, had an
accumulated deficit of approximately $109.6 million. There can be no assurance
that the Company will realize product revenues on a timely basis, if at all.
The Company's operations are subject to numerous risks associated with research
and development companies, including a competitive and regulatory environment
in an industry characterized by numerous well-established and well-capitalized
companies and exhaustive and expensive regulatory scrutiny. The Company will be
required to continue to conduct significant research, development and testing
activities which, together with projected general and administrative expenses,
are expected to result in continued substantial losses for the foreseeable
future.

         Need for Substantial Additional Funds.   The Company will require
substantial additional funds to continue its research and development programs
and to commercialize potential products. The Company may not have sufficient
funds to complete development activities for any of its proposed products,
including Cytolex.

         The Company intends to seek additional funding through a combination
of future offerings of securities and collaborative arrangements with third
parties, and regularly explores alternatives in this regard. The Company does
not have any commitments to obtain any additional funds and has no established
banking arrangements through which it can obtain additional debt financing.
There can be no assurance that future funding will be available to the Company,
or, if available, will be obtainable on terms favorable to the Company. The
receipt of funding, if any, from any corporate partners, including SB, will
depend largely on the progress of research and development programs. Under
collaborative arrangements, the Company may convey marketing, distribution,
manufacturing, development or other rights to its proposed products to
pharmaceutical companies in order to receive financial or other assistance.
This will result in lower consideration to the Company upon





                                       3

<PAGE>   6
commercialization of such products than if no arrangements were entered into or
if such arrangements were entered into at later stages in the product
development process. There can be no assurance that the Company will be able to
enter into such arrangements on favorable terms, if at all.

         If the Company does not enter into appropriate collaborations, receive
additional funds from SB under its current agreement, or raise sufficient funds
from the periodic sale of securities, the Company will be required to delay or
eliminate expenditures for potential products, including Cytolex, or to enter
into collaborations with third parties to commercialize potential products or
technologies that the Company would otherwise seek to develop itself, or seek
other arrangements.

         Manufacturing Uncertainties; Dependence on Third Parties.   The
Company does not have the resources, facilities or capabilities to manufacture
any of its proposed products. The Company has no current plans to establish a
manufacturing facility.  The Company expects that it will be dependent to a
significant extent on contract manufacturers for commercial scale manufacturing
of its proposed products in accordance with regulatory standards. The Company's
dependence on third parties for manufacturing may adversely affect operating
results as well as the Company's ability to develop and deliver products on a
timely and competitive basis. Production of peptides (such as Cytolex and other
magainins) is expensive relative to production of traditional antibiotics.
Additionally, there are a limited number of companies which are currently able
to produce bulk peptides on the scale which the Company expects to require to
commercialize Cytolex. There can be no assurance that qualified outside
contractors will be available to manufacture materials for the Company, or do
so at costs which are affordable by the Company.

         Contract manufacturers may utilize their own technology, technology
developed by the Company, or technology acquired or licensed from third
parties. When contract manufacturers develop proprietary process technology and
have ownership of the Drug Master File, the Company's reliance on such contract
manufacturer is increased, and the Company may have to obtain a license from
such contract manufacturer to have its products manufactured by another party.
Technology transfer from the original contract manufacturer may also be
required. There can be no assurance that any such license will be available on
terms acceptable to the Company, or, if available, that such technology will be
successfully transferred to the Company. Any such technology transfer may also
require transfer of requisite data for regulatory purposes, including
information contained in a proprietary Drug Master File held by a contract
manufacturer. There can be no assurance that any such transfer can be
completed.

         The Company is working with Abbott Laboratories ("Abbott") with regard
to development by Abbott of a solution phase chemical process to manufacture
bulk drug substance for Cytolex on a commercial scale. The Company is currently
dependent upon Abbott for the production of bulk drug substance for Cytolex. In
the event that bulk drug substance for Cytolex is not manufactured at Abbott,
the Company will need to secure other manufacturing arrangements. The process
developed by Abbott is proprietary, and in the event the Company desires to
utilize, or have another party utilize, such technology, the Company would be
required to make license payments to Abbott.  Further progress in scale-up and
manufacturing development efforts will be required to enable the Company to
manufacture and sell Cytolex on a profitable basis. This may require
substantial additional funds.  The Company has certain efforts underway with
respect to alternative manufacturing sources, including recombinant
manufacturing; however, these programs are at an early stage, and significant
expenditures over an extended period of time will be required to develop a
commercially viable process. No assurance can be given that a cost-effective
manufacturing process can ultimately be developed, or that any such process
would be approved by the FDA, or that the Company, Abbott, or others will be
able to manufacture Cytolex on a commercially viable basis.

         The Company also expects to conduct significant manufacturing
development activities for its other products under development. The Company is
currently working with outside contractors for the chemical production of
squalamine. The Company expects to expend significant resources in the
production of squalamine and any other compounds under development, and there
can be no assurance that these efforts will be successful.





                                       4

<PAGE>   7
         Dependence on Sales and Marketing Partners; Marketing Uncertainties.
In order to successfully develop and market its products, it will be necessary
for the Company to enter into marketing, distribution, development or other
arrangements with third parties, granting marketing rights, which may be
exclusive, to potential products. The Company has entered into such an
arrangement with SB with respect to Cytolex in North America, and intends to
seek a sales and marketing collaboration for Cytolex in other territories. Such
sales and marketing arrangements may also involve delegating to the Company's
partner in such collaborations the responsibility for all or a significant
portion of the development and regulatory approval process. In the event that
such collaborators do not develop an approvable or marketable product or do not
market a product successfully, the Company's business will be adversely
affected. There can be no assurance that the Company will be able to enter into
any such arrangements in the future, or that such collaborations will be
successful.

         The amount and timing of resources to be devoted to the Company's
products by any of its collaborative partners is not within the control of the
Company. There can be no assurance that the interests of the Company will
continue to coincide with the interests of its collaborators. Collaborators
could develop products independently or through third parties which could
compete with the Company's proposed products. With respect to Cytolex, SB
maintains a significant presence in the antibiotic area, and currently sells a
topical antibiotic product indicated for the treatment of certain skin
infections. Furthermore, SB may unilaterally terminate its agreement with the
Company. There can be no assurance that any of the Company's collaborative
agreements will not be terminated by the Company's collaborators.

         For certain products under development, the Company may conduct its
own marketing activities through its own sales force.  The Company has no
marketing and sales staff and, although certain members of management have
experience in the marketing of pharmaceutical products, the Company has no
experience with respect to marketing its proposed products. Significant
additional expenditures, management resources and time will be required to
develop a sales force, and there can be no assurance that the Company will be
successful either in developing a sales force or penetrating the markets for
any proposed products it may develop.

         Technological Uncertainty and Early Stage of Product Development.
There can be no assurance that the Company's research and development
activities will be successful, that any products under development will be
approved or will be commercially viable and successfully marketed, or that the
Company will ever achieve significant levels of revenue or profits. In
addition, the Company may encounter unanticipated problems, including
development, regulatory, manufacturing and marketing difficulties, some of
which may be beyond the Company's ability to resolve.

         There has been only limited research in the area of the use of
naturally occurring host defense compounds for the treatment of infectious and
other diseases. The Company has submitted an Investigational New Drug
Application ("IND") to the FDA, to obtain authorization for human testing, for
only two compounds, Cytolex and squalamine. The Company's research activities
in asthma have only recently been initiated, and there can be no assurance that
any product candidates will result from these efforts.  Additionally, there can
be no assurance that results obtained in preclinical studies will be indicative
of results that will be obtained in human clinical testing.

         The Company's proposed products are in the developmental stage,
require significant further research, development, testing and regulatory
approvals and are subject to the risks of failure inherent in the development
of all pharmaceutical products. These risks include the possibilities that any
or all of the proposed products are found to be ineffective or toxic, or
otherwise fail to receive necessary regulatory approvals, that the proposed
products, although effective, are uneconomical to manufacture or to market,
that third parties hold proprietary rights that preclude the Company from
marketing any products, or that third parties market superior or equivalent
products.

         No Assurance of Market Acceptance of Cytolex.   Even if the requisite
regulatory approvals for Cytolex are obtained, there is no assurance that such
product would be accepted in the United States or foreign markets. A number of
factors may affect the rate and overall market acceptance of Cytolex, including
the perception by physicians and other members of the health care community of
the safety and efficacy of Cytolex on an absolute





                                       5

<PAGE>   8
basis or in comparison to other drugs, the price of Cytolex relative to other
drugs or competing treatment modalities, the availability of third-party
reimbursement, and the effectiveness of the sales and marketing efforts by SB
and the Company relative to the sales and marketing efforts of competitors. In
addition, side effects or unfavorable publicity concerning Cytolex or
comparable drugs on the market could have an adverse effect on the Company's
ability to obtain physician, patient or third-party payor acceptance.

         Government Regulation.   The production and marketing of the Company's
products and its research and development activities are subject to regulation
by numerous governmental authorities in the United States and other countries.
In the United States, drug products are subject to rigorous review by the FDA.
The Federal Food, Drug, and Cosmetic Act and other federal statutes and
regulations govern or influence the testing, manufacture, safety, efficacy,
labeling, storage, recordkeeping, approval, advertising, promotion and
distribution of such products. Noncompliance with applicable requirements can
result in Warning Letters, fines, recall or seizure of products, refusal of the
government to approve marketing applications or to allow the Company to enter
into government supply contracts, the withdrawal of previously approved new
drug applications and criminal prosecution.

         In order to obtain FDA approval to market a new drug product, the
Company must submit proof of safety, efficacy and quality. Such proof entails
extensive and time consuming preclinical and clinical testing. The results of
preclinical studies are submitted to the FDA as part of an IND.  Once the IND
is effective, human clinical trials may be conducted.  The results of the
clinical trials are submitted to the FDA as part of an NDA.

         Detailed manufacturing information is also required to be included in
the NDA for review and approval by the FDA. Among other things, the Company must
submit data indicating that the drug product can be consistently manufactured at
the same quality standard, that the drug product is stable over time, and that
the level of chemical impurities in the drug product is under specified levels.
Peptides are an especially difficult compound to manufacture at these standards,
particularly in the quantities at which Cytolex will be required to be
manufactured.  Any contract manufacturers that the Company may use must adhere
to the Good Manufacturing Practices prescribed by the FDA. Drug manufacturing
facilities must pass a plant inspection before the FDA will issue approval to
market a new drug product.  There can be no assurance that the manufacturing
information submitted for Cytolex, or other products under development, will be
sufficient for approval by the FDA.

         Following extensive review of the NDA, the FDA may grant marketing
approval, require additional testing or information, or deny the application.
Sales of a new drug may commence following FDA approval of an NDA and
satisfactory completion of a pre-approval inspection of the manufacturing
facility, including a review of pertinent production records. If there are any
modifications to the drug, including any changes in indication, manufacturing
process, labeling or manufacturing facility, an NDA supplement may be required
to be submitted to the FDA. The FDA may also require post-marketing testing and
surveillance to monitor the effects of approved products or place conditions on
any approvals that could restrict the commercial applications of such products.
Product approvals may be withdrawn if compliance with regulatory standards is
not maintained or if problems concerning safety, efficacy or quality of the
product occur following approval.

         Continued compliance with all FDA requirements and conditions in an
approved application, including those concerning product specifications,
manufacturing process, validation, labeling, promotional material,
recordkeeping and reporting, is necessary for all approved drug products.
Failure to comply could result in Warning Letters, product recall or other
FDA-initiated actions, which could delay further marketing until the products
are brought into compliance.
         
         In October 1992, the Prescription Drug User Fee Act of 1992 ("PDUFA")
was enacted, imposing substantial fees on a one-time basis for applications for
approval, and on an annual basis for manufacturing and marketing of
prescription drugs. Legislation reauthorizing PDUFA is currently pending in
Congress and it is anticipated that such user fees will continue and may
increase in the future.

         The Company is also subject to regulation by other regulatory
authorities, including the Occupational Safety and Health Administration, the
Environmental Protection Agency, the Nuclear Regulatory Commission, the Drug
Enforcement Agency and the United States Department of Agriculture, and to
regulation under the





                                       6

<PAGE>   9
Toxic Substances Control Act, the Resource Conservation and Recovery Act and
other regulatory statutes, and may in the future be subject to additional
federal, state or local regulations. These agencies may promulgate regulations
that affect the Company's research and development programs.

         Sales of pharmaceutical products outside the United States are subject
to foreign regulatory requirements that vary widely from country to country.
Whether or not FDA approval has been obtained, approval of a product by
comparable regulatory authorities of foreign countries must be obtained prior
to the commencement of marketing the product in those countries. The time
required to obtain such approvals may be longer or shorter than that required
for FDA approval.

         There can be no assurance that any required FDA or other governmental
approval will be granted, or if granted, will not be withdrawn. Governmental
regulation may prevent or substantially delay the marketing of the Company's
proposed products, cause the Company to undertake costly procedures, and
furnish a competitive advantage to the more substantially capitalized companies
with which the Company competes. In addition, the extent of potentially adverse
government regulations which might arise from future administrative action or
legislation cannot be predicted. Efforts are currently underway in the U.S.
Congress to reform federal regulation of drug and biological products. The
reform provisions, when and if implemented, could modify a number of existing
legal requirements and standards and create new legal requirements and
standards. Although certain of these provisions, if implemented, could
streamline and otherwise benefit development, marketing and related
requirements for drugs and biologics, others could increase regulatory
requirements or otherwise materially adversely affect the Company.

         Competition.   The pharmaceutical industry is characterized by intense
competition. Many companies, research institutions and universities are working
in a number of areas similar to the Company's field of interest. The Company is
aware that research is being conducted by others in connection with compounds
derived from the host defense systems of various animals. Additionally, many
companies are involved in research and development activities focused on the
pathogenesis of disease, and competition among companies attempting to find
genes responsible for disease is intense. Furthermore, many companies are
engaged in the development and sale of products, such as traditional
antibiotics, which may be, or are, competitive with the Company's proposed
products. Most of these entities have substantially greater financial,
technical, manufacturing, marketing, distribution and other resources than the
Company. The Company's proposed products will also be subject to competition
from products using techniques other than those developed by the Company or
based on advances that may render the Company's products obsolete.

         The Company expects technological developments in the
biopharmaceutical field to occur at a rapid rate and expects competition to
intensify as advances in this field are made. Accordingly, the Company will be
required to continue to devote substantial resources and efforts to research
and development activities in order to maintain a competitive position in this
field.  Compounds, products or processes developed by the Company may become
obsolete before the Company is able to recover a significant portion of its
research and development expenses. The Company will be competing with respect
to its proposed products with companies that have significantly more experience
in undertaking preclinical testing and human clinical trials of new or improved
therapeutic products and obtaining regulatory approvals of such products. Some
of these companies may be in advanced phases of clinical testing of various
drugs that may be competitive with the Company's proposed products.

         Colleges, universities, governmental agencies and other public and
private research organizations are becoming more active in seeking patent
protection and licensing arrangements to collect royalties for use of
technology that they have developed, some of which may be directly competitive
with that of the Company. In addition, these institutions, along with
pharmaceutical and specialized biotechnology companies, can be expected to
compete with the Company in recruiting highly qualified scientific personnel.

         As to the disease areas being targeted by the Company, there can be no
assurance that Cytolex will be successfully marketed against oral antibiotics
for the treatment of infection in diabetic foot ulcers. These infections have
historically been treated with systemically administered antibiotics, such as
ofloxacin, which





                                       7

<PAGE>   10
         may be perceived by some medical professionals as having certain
advantages over Cytolex. There also can be no assurance that Cytolex can be
manufactured at a cost which will allow it to be sold at a competitive price
relative to oral antibiotics, or other topical antibiotics that may be used for
this indication. Significant efforts are underway by many companies in the
development and marketing of products intended for the additional disease areas
being targeted by the Company, including cancer and asthma. A number of major
pharmaceutical companies have significant franchises in these disease areas, and
can be expected to invest heavily to protect these interests. In addition, in
the cancer field, anti-angiogenic agents are under development at a number of
companies. In the asthma field, other biopharmaceutical companies have also
reported the discovery of genes relating to asthma.

         Uncertainties Relating to Patents and Proprietary Rights.   The
Company's success will depend in part upon its ability to obtain patent
protection for compounds, uses of compounds, and processes. Patent matters
involve complex legal and factual issues, and can be highly uncertain. Host
defense compounds can be isolated from a wide variety of sources, and it is not
possible for the Company or any other entity to have proprietary rights to all
such compounds or their uses. Additionally, chemical entities that are similar
to, but not identical with, the Company's compounds, may not be protected by
issued patents of the Company. In the genomics area, a number of companies are
attempting to rapidly identify and patent genes whose functions have not been
characterized.  Additional companies are seeking to patent fully characterized
genes. The criteria for obtaining patent protection for genes is unclear and
the impact of this uncertainty on the Company's business cannot be determined.

         The Company owns or has exclusive rights under license agreements to
45 issued patents, and an additional 26 patent applications are pending,
including the patent application relating to Cytolex. Of the 71 patents or
patent applications to which the Company has rights, 45 are related to host
defense and 26 are related to the Company's research efforts in genomics. There
can be no assurance that any patent applications now pending or filed in the
future will result in patents being issued or that any patents now held by or
licensed to the Company, or issued or licensed to the Company in the future,
will afford any competitive advantages for the Company, or will not be
challenged by third parties. The cost of litigation to uphold the validity and
prevent infringement of patents and to enforce licensing rights can be
substantial. Furthermore, there can be no assurance that others will not
independently develop similar technologies or duplicate the technology owned by
or licensed to the Company or design around the patented aspects of such
technology. In addition, there can be no assurance that the products and
technologies the Company will seek to market will not infringe patents or other
rights owned by others, licenses to which may not be available to the Company.

         The Company also relies upon unpatented proprietary technology, and
may determine in appropriate circumstances that its interest would be better
served by reliance on trade secrets or confidentiality agreements rather than
patents. There can be no assurance that others will not independently develop
substantially equivalent proprietary information and techniques or otherwise
gain access to such proprietary technology or that the Company can meaningfully
protect its rights in such unpatented proprietary technology. Additionally, if
the Company is unable to obtain strong proprietary rights protection of its
products after obtaining regulatory clearance, competitors may be able to
market competing products by obtaining regulatory clearance, through showing
equivalency to the Company's product, without being required to conduct the
lengthy clinical tests required to be conducted by the Company.

         Virtually all of the Company's key scientists worked at other
biotechnology or pharmaceutical companies or at universities and research
institutions before joining the Company. Disputes may arise as to whether
technology developed by such scientists while employed by or associated with
the Company was first discovered when they were employed by or associated with
others in a manner that would give third parties rights to such technology
superior to the rights, if any, of the Company. Disputes of this nature have
occurred in the past, and are expected to continue to arise in the future, and
there can be no assurance that the Company will prevail in any such disputes.
         
         To the extent that consultants, vendors or other third parties apply
technological information independently developed by them or by others to the
Company's proposed products, disputes may arise as to the





                                       8

<PAGE>   11
proprietary rights to such information, which may not be resolved in favor of
the Company. Consultants to the Company are employed by or have consulting
agreements with third parties, and any inventions discovered by such
individuals are not likely to become the property of the Company.

         The Company has rights under license agreements to certain patents and
patent applications under which the Company expects to owe royalties on sales
of any products which are covered by issued patent claims. Additionally,
certain of these agreements also provide that if the Company elects not to
pursue the commercial development of any licensed technology, or does not
adhere to an acceptable schedule of commercialization, then the Company's
exclusive rights to such technology would terminate.

         Dependence on Key Personnel.   The Company depends to a considerable
degree on a limited number of key personnel. Due to the Company's limited
number of employees, many key responsibilities within the Company have been
assigned to a relatively small number of individuals. The Company does not
maintain "key man" insurance on any of its employees. The loss of certain
senior management could adversely affect the business of the Company. The
success of the Company will depend, among other factors, upon the successful
recruitment and retention of qualified personnel.

         Product Liability and Insurance Risks.   Before obtaining required
regulatory approvals for the commercial sale of products, the Company must
demonstrate through human clinical testing that such products are safe and
efficacious for use in each target indication. The administration of any
product being developed by the Company could produce undesirable side effects
in humans. The Company carries limited clinical trial insurance, and there can
be no assurance that such coverage is adequate.

         In addition, in the event the Company successfully develops any
products, the marketing of such products could expose the Company to product
liability claims. Certain agreements require the Company to maintain insurance
coverage naming third parties as additional insureds at such time as any
related products may be marketed. There can be no assurance that the Company
will be able to obtain such insurance or that such insurance can be maintained
in sufficient amounts to protect the Company against such liabilities or at a
reasonable cost. Certain arrangements also require the Company to indemnify
third parties with whom the Company has entered into contractual arrangements
against any liabilities that may arise in connection with such third party's
activities on behalf of the Company.

         In the event of an uninsured or inadequately insured claim, the
Company's business and financial condition could be materially adversely
affected.

         Uncertainty Related to Reimbursement Policies; Health Care Reform.
Successful commercialization of Cytolex and the Company's other potential
products will be dependent in part on the coverage and reimbursement of such
products from third-party payors, such as government authorities, private
health insurers and other organizations, such as managed care organizations.
There can be no assurance that such coverage and reimbursement will be
available or, if available, will be in adequate amounts.

         The revenues and profitability of pharmaceutical companies can be
significantly affected by the efforts of governmental and third-party payors to
contain or reduce the cost of health care through various means. For example,
in the United States, pricing of prescription pharmaceutical products has been
impacted by the efforts of managed care organizations and other third-party
payors, and, in certain foreign markets, pricing of prescription pharmaceutical
products is subject to government control. Government and third-party payors
have also taken more aggressive steps to limit the availability of new and
often more costly therapeutics especially where they believe that the
incremental therapeutic benefit is not justified by the additional cost. All of
these trends are expected to continue in the future.

         Various proposals have been put forth to reform the current health
care system in the United States. Additionally, several states have enacted
modifications to the current health care system to both improve access and
control costs. Such reform measures could adversely affect the amount of
reimbursement available from governmental agencies or third party insurers, or
could affect the ability to set prices for newly approved





                                       9

<PAGE>   12
therapeutic products. Similar proposals are being considered by governmental
officials in other significant pharmaceutical markets, including Europe.

         The Company cannot predict if such reforms will be implemented or the
effect any such reforms might have on the Company's business, and no assurance
can be given that any such reforms will not have an adverse effect on the
Company's business. In particular, it is possible that any such reform could
impact the manner in which drugs or therapies are marketed and could include
restrictions on the ability of pharmaceutical and biotechnology companies to
price drugs or therapies, which in turn could impact the ability of
biotechnology companies, such as the Company, to obtain financing for the
continued development of potential products.  Furthermore, any such reform
could also impose limits on the overall growth of health care spending, as well
as limits on the growth of Medicare and Medicaid spending, all of which could
have an adverse effect on the Company.

         Possible Volatility of Stock Price.   The market prices for securities
of emerging and biotechnology companies, including the Company, have
historically been highly volatile. Future events concerning the Company or its
competitors, including product testing results, technological innovations, new
commercial products, government regulations, proprietary rights, regulatory
actions, litigation and other matters, may have a significant impact on the
market price of the Common Stock.

         Effect of Exercise of Options and Warrants, and Other Issuance of
Shares.   As of December 31, 1997, the Company had outstanding options to
purchase 2,974,000 shares at prices ranging from $.002 per share to $16.75 per
share, of which 1,586,000 were exercisable as of such date. Also outstanding at
December 31, 1997 were warrants to purchase 229,739 shares of the Company's
Common Stock exercisable at $8 per share, a warrant to purchase 300,000 shares
of the Company's Common Stock, exercisable at $7.50 per share, and warrants to
purchase an aggregate of 1,017,872 shares of the Company's Common Stock,
exercisable at $8.43 per share, subject to adjustment. Exercise of options and
warrants at prices below the market price of the Company's Common Stock could
adversely affect the price of the Company's Common Stock. Additional dilution
may result from the issuance of shares in connection with collaborations or
manufacturing arrangements, or in connection with other financings.





                                       10

<PAGE>   13
THE COMPANY  

         Background

         Magainin's biopharmaceutical research and development efforts are
focused on two technology platforms. In host defense drug discovery, the
Company seeks to isolate and develop therapeutically active compounds from
various organisms for the treatment of human diseases. The Company's second
platform technology is a gene-based target and drug discovery program in
asthma. The Company employs a broad range of genomics techniques to identify
genes associated with the pathogenesis of asthma, with the objective of
utilizing the optimal biologic gene targets in the development of novel
therapeutics for asthma and allergy.

         Host Defense System

         The Company was formed to engage in the research, development and
commercialization of compounds derived from the host defense systems of
animals. The host defense system is the complex of natural processes and
mechanisms used by the body to protect itself against infection and certain
cancers. This system comprises physical barriers to infection, such as skin and
mucosal membranes and fluids, as well as more complex chemical and biological
components, such as the immune system. The Company believes that certain
classes of naturally occurring peptides, such as magainins, and certain small
molecules, such as aminosterols, both described below, are used by the host
defense system to provide a first line of defense against infection and may
have activity against certain cancers.

         The Company's approach to identifying pharmaceutically active
compounds in the host defense systems of animals involves the extraction of
compounds from animal tissues. The extracts are assayed for activity against
selected pathogens, such as bacteria, fungi, viruses and certain cancers. The
Company then purifies the active compounds and determines the precise chemical
structure of the purified molecule. Once naturally occurring molecules have
been isolated, the Company analyzes the relationship between the molecular
structure of the compound and its biological activity. In general, this
requires identification of the structures in the compound which are believed to
have therapeutic effects and an analysis of how the compounds could be modified
to improve the desired therapeutic effects. The Company then utilizes its
combinatorial chemistry capabilities to modify the molecules to alter
biological activity or increase stability.

         Magainins

         The Company's lead product development candidate, Cytolex, is a
synthetic magainin peptide. The first magainins were isolated from the African
frog Xenopus laevis by Dr. Michael A. Zasloff (presently Vice Chairman and
Executive Vice President of the Company) while conducting genetic and molecular
biological research at the National Institutes of Health ("NIH") in 1987. In
connection with his research, Dr. Zasloff was performing surgery on African
clawed frogs in his laboratory. After suturing the frogs and returning them to
their aquarium tank, he noticed that the incisions healed without infection,
inflammation or notable scarring, despite being exposed to the bacteria-filled
aquarium water. Dr. Zasloff deduced that the frogs produced a substance that
protected them against infection. Eventually, he isolated, from the skin, two
related peptides, which he called magainins and which were later shown to kill
a variety of pathogens, including bacteria, amoeba, fungi and parasites.

         Magainins are peptides. A peptide is a chain of molecules, known as
amino acids, that are considered to be one of the basic building blocks of the
human body. Chains of two to 50 amino acids are generally referred to as
peptides, while longer chains are referred to as proteins. Magainins are
shorter-chain peptides, and can be synthesized chemically as well as by
recombinant technology. Chemical synthesis permits greater flexibility in
manipulating the sequence of amino acids, enabling the Company to create and
test derivative compounds more rapidly and efficiently than using recombinant
technology. The Company has modified natural peptides by rearranging the order
and combination of amino acids and by substituting and deleting additional
amino acids to produce magainins having a broader spectrum of therapeutic
activity and improved potency.





                                       11


<PAGE>   14
         An increasing problem in the antibiotic field is resistance, the
process by which antibiotics lose their effectiveness over time as bacteria,
through mutation, develop the means to produce enzymes capable of diminishing
the antibiotic utility. To date, the Company has not noted the development of
resistance to magainins. The Company believes this is due to the means by which
magainins break down pathogen cells and kill pathogens, which mechanism of
action differs from traditional antibiotics. In the presence of a cell membrane
rich in acidic phospholipids and poor in cholesterol, such as bacterial
membranes, magainins twist into two-sided, spiral shaped molecules (helices),
with one side soluble in the fat-like substance that comprise cell membranes
and the other side soluble in water. Individual magainin peptides then
aggregate and line up to form a channel in the membrane of a pathogen. Once
formed, this aggregate punctures the cell membrane, breaks down the integrity
of the cell and kills the pathogen.

         Aminosterols and Angiogenesis

         Squalamine is the lead product development candidate in the Company's
aminosterol program. squalamine was discovered in the body tissues of the
dogfish shark. The shark was initially examined because of its known resistance
to infection and cancer. The chemical structure of squalamine uniquely combines
a steroid and a polyamine, two classes of systemic agents that are generally
well-tolerated in humans. Since 1992, the Company has discovered several other
aminosterol compounds in the shark. In preclinical testing, certain of these
compounds have demonstrated an ability to control cell growth, along with other
pharmacological properties. These properties may have application in the
treatment of a number of disease indications characterized by cell
proliferation, including cancer.

         Within the human body, a network of arteries, capillaries and veins,
known as the vasculature, functions to transport blood throughout the body.
The basic network of the vasculature is developed through angiogenesis, a
fundamental process by which new blood vessels are formed. The primary
angiogenic period in humans takes place during the first three months of
embryonic development. During this period, cytokines and growth factors are
activated to stimulate the growth of new blood vessels. Once the general
network of the blood vessels is complete, these angiogenic stimulators are
balanced and stabilized by the production of inhibitory factors. Although
angiogenesis occurs in human embryonic development, wound healing and in
certain reproductive processes in women, angiogenesis is also associated with
several diseases, including cancer, as well as diabetic retinopathy and macular
degeneration, both of which are major causes of blindness.

         The term cancer includes many different types of uncontrolled cellular
growth. Clusters of cancer cells, referred to as tumors, may invade and destroy
surrounding organs, impair physiological function and lead to death. In order
to survive, cancer cells require oxygen and nutrients which they receive from
the body's blood supply. In order to access this blood supply, cancer cells
initiate a biochemical mechanism that stimulates angiogenesis, which provides
the blood supply that nourishes the tumor. As cancer cells grow and metastasize
(spread from primary sites to secondary sites) they require continuous
angiogenesis.  Anti-angiogenic substances are intended to inhibit the growth of
new blood vessels and may therefore be effective in treating certain cancers,
with potentially less serious and fewer adverse side effects than traditional
therapies.

         The aminosterol compounds are believed by the Company to have a unique
mechanism of action whereby they inhibit cell proliferation at an early stage
in cell activation by blocking the function of certain ion transporters in the
cell membrane. These transporters act as pumps on the surface of cells, and
control cell function through regulation of intracellular pH, cell metabolism
and cell volume. In the case of squalamine, there is a blockade of function for
a specific sodium proton exchanger in the cell membrane of certain endothelial
cells which leads to a cessation of endothelial cell proliferation, and as a
consequence, capillary formation. Thus, squalamine is believed by the Company
to limit growth promoting signals from several different growth stimulatory
factors.





                                       12

<PAGE>   15
         Genomics and Drug Discovery

         Advances in genetics and molecular biology have significantly enhanced
the ability of scientists to clone and sequence genes and identify the causes
of disease at the molecular level. The examination of the genetic influences on
human disease is called genomics, or the study of the genome. Functional
genomics refers to the determination of the manner in which disease genes
specifically impact the disease process. In contrast to traditional drug
discovery and development, a genetics approach commences by identifying those
genes that are responsible for the initiation or progression of disease.
Analysis of DNA (deoxyribonucleic acid) helps characterize the specific role of
genes in the disease process. The information stored in the DNA of a gene is a
set of instructions to living cells of the organism. These instructions direct
the cells to synthesize specific proteins such as hormones or enzymes that
perform the basic biochemical and physiological functions of the cells. Disease
may occur when a defect (mutation) occurs in a gene or genes, resulting in
incorrect instructions being sent to cells, and disrupting the normal balance
or function of these essential proteins. The ability to detect such a mutation
and to understand how the disruption of normal protein function contributes to
the initiation and progression of the resultant disease are potentially
valuable aids to pharmaceutical discovery and development. To identify an
appropriate molecular target for therapeutic intervention, it may also be
necessary to characterize fully the biochemical pathway in which the disease
gene functions.

          The Company employs a comprehensive functional genomics approach to
understand the genetic basis of disease and to develop potential drug leads.
The key elements of the Company's asthma genomics program include:

          Gene Identification--To link a disease with specific genes,      
     DNA and relevant clinical information is collected from families and     
     isolated individuals afflicted with the disease. The DNA from each       
     individual of the families is tested with DNA mapping markers, which     
     when analyzed give a chromosomal location for a disease gene. The        
     process is then extended to more detailed DNA mapping studies of the     
     chromosomal area, and the identification of genes located in the area    
     that may be associated with the disease. These genes are screened for    
     mutations (defects) using DNA sequencing and other techniques and then   
     correlated based on inherited disease patterns in families and           
     isolated discrete populations. Parallel studies of gene mapping and      
     mutation analyses of animal models of a disease process are often        
     possible, and provide complimentary information. Genetic defects         
     related to disease susceptibility and progression are thus identified.   
                                                                              
          Target Validation--Genes identified as potential targets for     
     pharmaceutical intervention undergo an integrated analysis using         
     advanced in vitro and in vivo bench techniques to elucidate mechanisms   
     of disease initiation and progression. This process, known as target     
     validation, provides further evidence of the relevance of the            
     identified genes to particular portions of the disease process, and      
     guides the selection of strategies for pharmaceutical intervention.      
     The Company uses an integrated approach of biochemistry, genetics,       
     cellular and molecular biology, and animal models of the disease in      
     the target validation process.                                           
                                                                              
          Pathway Elucidation--To identify an appropriate target for       
     therapeutic intervention, it is highly desirable to know how the         
     disease genes are turned on or off (gene regulation pathways) and how    
     the gene functions within the biochemical processes of cells (signal     
     transduction pathways). The discovery process for novel regulatory and   
     signaling proteins involves a combination of biochemical, molecular,     
     biological and genetic approaches.                                       
                                                                              
          Target Specific Assay Development--Targets identified as         
     appropriate for therapeutic intervention are placed in biochemical and   
     cell based assay systems that closely mimic their native environment.    
     In a biochemical assay, the components and mechanism of action of the    
     target proteins are known. Since biochemical assays are usually          
     amenable to high-throughput screening, results can be obtained rapidly   
     and reproduced consistently. As a complimentary approach, cell based     
     assays extend the biochemical screening capabilities by allowing         
     analysis of sample activity in a physiologically relevant environment    
     while similarly permitting the assessment of cytotoxicity and cell       
     permeability. Cell based screens provide                                 





                               13

<PAGE>   16
     multiple sites of therapeutic intervention to be assessed at one time,
     such as the receptors, regulatory proteins, and signaling proteins
     involved in a pathway.

         Through these processes, the Company seeks to identify appropriate
targets for pharmaceutical intervention that aim to control the root cause of
human disease. The Company believes that pharmaceuticals developed for use
against these specific targets have the potential for greater effectiveness and
fewer side-effects than pharmaceuticals developed through more traditional
processes.





                                       14

<PAGE>   17
Product Development and Research Programs

         Cytolex--Infected Diabetic Foot Ulcers

         The Company's most advanced development compound is Cytolex, a topical
cream antibiotic. Cytolex is a 22 amino acid magainin peptide, formulated as a
1% topical cream. In vitro studies of Cytolex have shown that it is a broad
spectrum anti-infective, effective against gram negative, gram positive and
fungal organisms. The Company's initial intended use for Cytolex is for the
treatment of infection in diabetic foot ulcers.

         Infected foot ulcers in diabetic patients are a serious complication.
The often compromised vasculature and nervous systems in the diabetic patient
can create conditions conducive to foot ulceration and consequent infection.
These infections can lead to osteomyelitis (bone infection) and limb
amputation. Patients with infected ulcers are typically treated with oral
antibiotics and no topical antibiotics are currently approved specifically for
the treatment of infection in diabetic foot ulcers.

         The Company believes that topical antibiotics may offer advantages
over oral antibiotics in the treatment of infection in diabetic foot ulcers.
Increasing utilization of oral antibiotics has exacerbated the development of
antibiotic resistance, and resistant organisms are expected to continue to
develop. Additionally, there can be side effects associated with oral
antibiotics, including gastrointestinal distress, headaches and insomnia. The
Company believes that a topical treatment for diabetic foot ulcers may also
improve patient compliance with their medication and associated wound care.

         In September 1996, the Company reported results of its initial,
pivotal Phase III clinical trial of Cytolex, and in March 1997, the Company
reported results from a second such pivotal trial. These trials were designed
as equivalence studies with the goal of demonstrating that Cytolex topical
cream is as effective as orally administered ofloxacin, a quinolone antibiotic,
indicated for the treatment of infection, including skin and soft tissue
infections. The Company intends to submit an NDA with the FDA based on the
results of these clinical trials early in the second half of 1998; however,
there can be no assurance that Cytolex will be approved by the FDA. (See Item 1
- Risk Factors: "Risks Associated with Clinical Testing and FDA Approval of
Cytolex.")


         Squalamine--Solid Tumors

         Squalamine is the Company's lead product development candidate in its
aminosterol program. The Company's initial disease focus for squalamine is
solid tumors.  The Company is currently conducting Phase I clinical testing of
squalamine in patients with advanced malignancy.

         Cancer is the second most common cause of death in the Western world,
exceeded only by coronary heart disease. The three most prevalent methods of
treating patients with cancer are surgery, radiation therapy and chemotherapy.
A cancer patient often receives a combination of these treatment methods.
Surgery and radiation therapy are particularly effective in patients in which
the disease has not yet metastasized to other tissue or organs. Chemotherapy is
the principal treatment for tumors that have metastasized. Chemotherapy
involves the administration of drugs designed to kill cancer cells ("cytotoxic
drugs") or the administration of hormone analogues to either reduce the
production of, or block the action of, certain hormones, such as estrogens and
androgens, which affect the growth of tumors. Because chemotherapeutic agents
generally attack rapidly dividing cells indiscriminately, damaging normal as
well as cancerous cells, use of such agents often has serious adverse effects.
Additionally, resistance to chemotherapy inevitably occurs over time.

         Advances in the understanding of the genesis and development of cancer
have begun to yield new approaches to cancer treatment. One such approach is
the control of angiogenesis, or new blood vessel growth. Angiogenesis is a key
stage in the development of tumor malignancy, and its inhibition should
contribute to the tumor becoming or remaining dormant.

         Squalamine may be of benefit in the treatment of solid tumors by
inhibiting new blood vessel growth





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<PAGE>   18
required for tumor nourishment. Squalamine has exhibited anti-angiogenic
properties in a number of in vitro and in vivo assays, and in animal models.
Squalamine is believed to inhibit the growth of primitive or embryonic
capillaries associated with tumor growth.  Squalamine has the potential to be
used in combination with a number of cytotoxic drugs in the treatment of solid
tumors, and the Company has observed synergies with certain such cytotoxic
therapies in animal testing.


         Asthma Genomics Program

         Asthma is characterized clinically by wheezing and shortness of breath
due to reversible bronchospasm. It is a chronic, disabling disorder that
appears to be increasing in prevalence and severity. The complex
pathophysiology of asthma is under intensive scrutiny; however, its precise
causes are not well understood. A number of studies suggest a genetic component
to asthma, but family studies have been difficult to interpret due to other
influences, including allergens and pollutants. Allergic diseases, including
allergic rhinitis, are often present in individuals with asthma, but are also
important disease entities by themselves.  The Company believes the genetic
susceptibility factors for asthma and allergy will be, at least in part,
related to one another.  Current treatments for asthma and allergy are limited
to controlling inflammation or treating airway constriction through use of
bronchodilators.

         In 1996, Magainin initiated a research program in the genomics of
asthma. These efforts led to the identification of AAF1, a gene which varies in
DNA structure and function in asthmatic and allergic humans and animals. The
Company maintains a comprehensive research and development program to identify
additional genes in the AAF1 biologic pathway, which other genes are believed
to be important in mediating the allergic responses controlled by AAF1. AAF2
has been discovered in humans as a key second gene candidate in the AAF1
pathway, and other genes have also been identified by the Company. The Company
has filed patent applications and has licensed intellectual property relating
to AAF1, AAF2 and certain other genes in the treatment of asthma and allergy.
The Company continues to investigate the role of these genes in the allergic
inflammatory response, with the objective of utilizing the optimal biologic
gene targets in the development of novel therapeutics for asthma and allergy.

         Other Research Programs

         The Company is evaluating additional magainin peptides in a number of
disease indications. One such program is directed toward the treatment of
pseudomonas infections in cystic fibrosis patients. In this program, early
stage efforts include compound formulation activities necessary to deliver the
peptide in an aerosolized manner appropriate for inhalation therapy. Additional
magainin peptides are under evaluation in the treatment of other infections.

         The Company is also pursuing other research programs related to
squalamine. Due to the unique mechanism of action of squalamine, it may also
have application in a number of disease conditions characterized by abnormal
blood vessel growth, including rheumatoid arthritis, diabetic retinopathy,
psoriasis and age related macular degeneration of the eye. Additionally, the
Company has early research efforts directed toward the reformulation of
squalamine as an oral agent. As compared to the current intravenous
formulation, an oral formulation of squalamine may be of benefit in the
treatment of chronic disease conditions.

         The Company has discovered a number of other aminosterol compounds in
the shark, each differing from squalamine in chemical structure. Each is
believed to interact with a different, specific receptor, and, as a
consequence, alter the intracellular metabolism in a manner that disturbs the
target cell response to certain growth factors, hormones and other signals. The
Company is evaluating the role of aminosterols in altering metabolism as it
affects obesity. Other therapeutic opportunities for these compounds may
include various malignancies, inflammatory diseases, and viral infections.

         In addition, the Company has a number of other early stage research
programs. In one such program, the Company is engaged in research efforts on
defensins. Defensins are compounds found in animals and man





                                       16

<PAGE>   19
which have host defense properties similar to magainins and aminosterols. The
Company believes that the longer-term evolution of the host defense field may
lie in the discovery of compounds that regulate endogenous defensin expression,
rather than direct application of the defensin molecules themselves.

         The Company conducts the majority of its research and development
activities through its own staff and facilities, including the Magainin
Research Institute, an internal division of the Company focused on host defense
research, and the Magainin Institute of Molecular Medicine, an internal
division of the Company focused on the genomics of asthma. The Company also
employs contract research organizations, independent consultants and other
research professionals to aid in its research and development activities.

Collaborative Arrangements

         Development and Marketing Collaborations.   Collaborations may allow
the Company to leverage its own scientific and financial resources and gain
access to markets and technologies that would not otherwise be available to the
Company. In the long term, development and marketing arrangements with
established companies in the markets in which potential products will compete
may allow the Company's products easier access to their intended market and may
accordingly conserve Company resources. The Company expects that it will enter
into development and marketing arrangements for most of the products it may
develop. From time to time, the Company holds discussions with various
potential partners.

         In February 1997, the Company entered into a development, supply and
distribution agreement (the "Agreement") in North America with SB for Cytolex.
SB has paid the Company $10.0 million under this Agreement, and may make
additional payments to Magainin of up to $22.5 million upon the occurrence of
certain product milestones. SB will also fund a percentage of any development
expenses for any additional indications for Cytolex. Upon the commencement of
commercial sales by SB, Magainin will be responsible for the supply of Cytolex
and SB will be responsible for the marketing and sales of Cytolex. Magainin
will receive certain percentages of SB sales revenues under agreed upon terms.
The Agreement also gives SB the right to negotiate for rights to another
Magainin product development candidate, under certain terms and conditions. The
Agreement gives SB the right to terminate on a country by country basis if SB
determines it is not economical to distribute Cytolex in those areas. (See Item
1 - Risk Factors: "Need for Substantial Additional Funds" and "Dependence on
Sales and Marketing Partners; Marketing Uncertainties".)

         Research and License Agreements.   The Company has rights under
license agreements to several patents and patent applications under which the
Company expects to owe royalties on sales of any products which are covered by
issued patent claims.  Additionally, certain of these agreements also provide
that if the Company elects not to pursue the commercial development of any
licensed technology, or does not adhere to an acceptable schedule of
commercialization, then the Company's exclusive rights to such technology would
terminate. The Company also funds research at certain institutions, and these
relationships may provide the Company with an option to license any results of
the research.





                                       17

<PAGE>   20
Manufacturing

         The Company does not have the resources, facilities or capabilities to
manufacture any of its proposed products. The Company has no current plans to
establish a manufacturing facility. The Company expects that it will be
dependent to a significant extent on contract manufacturers for commercial
scale manufacturing of its proposed products in accordance with regulatory
standards. The Company's dependence on third parties for manufacturing may
adversely affect operating results as well as the Company's ability to develop
and deliver products on a timely and competitive basis. Production of peptides
(such as Cytolex and other magainins) is expensive relative to production of
traditional antibiotics. Additionally, there are a limited number of companies
currently able to produce bulk peptides on the scale which the Company expects
to require to commercialize Cytolex. There can be no assurance that qualified
outside contractors will be available to manufacture materials for the Company,
or do so at costs which are affordable by the Company.

         Contract manufacturers may utilize their own technology, technology
developed by the Company, or technology acquired or licensed from third
parties. When contract manufacturers develop proprietary process technology and
have ownership of the Drug Master File, the Company's reliance on such contract
manufacturer is increased, and the Company may have to obtain a license from
such contract manufacturer to have its products manufactured by another party.
Technology transfer from the original contract manufacturer may be required.
There can be no assurance that any such license will be available on terms
acceptable to the Company, or, if available, that such technology will be
successfully transferred to the Company. Any such technology transfer may also
require transfer of requisite data for regulatory purposes, including
information contained in a proprietary Drug Master File held by a contract
manufacturer. There can be no assurance that any such transfer can be
completed.

         The Company is working with Abbott with regard to development by
Abbott of a solution phase chemical process to manufacture bulk drug substance
for Cytolex on a commercial scale. The Company is currently dependent upon
Abbott for the production of bulk drug substance for Cytolex. In the event that
bulk drug substance for Cytolex is not manufactured at Abbott, the Company will
need to secure other manufacturing arrangements. The process developed by
Abbott is proprietary, and in the event the Company desires to utilize, or have
another party utilize, such technology, the Company would be required to make
license payments to Abbott.  Further progress in scale-up and manufacturing
development efforts will be required to enable the Company to manufacture and
sell Cytolex on a profitable basis. This may require substantial additional
funds.  The Company has certain efforts underway with respect to alternative
manufacturing sources, including recombinant manufacturing; however, these
programs are at an early stage, and significant expenditures over an extended
period of time will be required to develop a commercially viable process. No
assurance can be given that a cost-effective manufacturing process can
ultimately be developed, or that any such process would be approved by the FDA,
or that the Company, Abbott, or others will be able to manufacture Cytolex on a
commercially viable basis.

         The Company also expects to conduct significant manufacturing
development activities for its other products under development. The Company is
currently working with outside contractors for the chemical production of
squalamine. The Company expects to expend significant resources in the
production of squalamine and any other compounds under development, and there
can be no assurance that these efforts will be successful.

Government Regulation

         The production and marketing of the Company's products and its
research and development activities are subject to regulation by numerous
governmental authorities in the United States and other countries. In the
United States, drug products are subject to rigorous review by the FDA. The
Federal Food, Drug, and Cosmetic Act and other federal statutes and regulations
govern or influence the testing, manufacture, safety, efficacy,





                                       18

<PAGE>   21
labeling, storage, recordkeeping, approval, advertising, promotion and
distribution of such products. Noncompliance with applicable requirements can
result in Warning Letters, fines, recall or seizure of products, refusal of the
government to approve marketing applications or to allow the Company to enter
into government supply contracts, the withdrawal of previously approved new
drug applications and criminal prosecution.

         In order to obtain FDA approval to market a new drug product, the
Company must submit proof of safety, efficacy and quality. Such proof entails
extensive and time consuming preclinical and clinical testing. The results of
preclinical studies are submitted to the FDA as part of an IND. Preclinical
studies involve laboratory evaluation of product characteristics and animal
studies to assess the efficacy and safety of the product. Once the IND is
effective, human clinical trials may be conducted. Human clinical trials are
typically conducted in three sequential phases, but the phases may overlap.
Phase I trials consist of testing the product in a small number of patients or
healthy volunteer subjects primarily for safety at one or more doses. In Phase
II, in addition to safety, the efficacy of the product is evaluated in a
patient population somewhat larger than Phase I trials. Phase III trials
typically involve additional testing for safety and clinical efficacy in an
expanded population at geographically dispersed test sites. A clinical plan, or
"protocol," accompanied by the approval of the Institutional Review Board
participating in the trials, must be submitted to the FDA prior to commencement
of clinical trials. Various reports must be submitted to the FDA during the
course of the trials, and the FDA may order the temporary or permanent
discontinuation of a clinical trial at any time. The results of the clinical
trials are submitted to the FDA as part of an NDA. 

         Detailed manufacturing information is also required to be included in
the NDA for review and approval by the FDA. Among other things, the Company
must submit data indicating that the drug product can be consistently
manufactured at the same quality standard, that the drug product is stable over
time, and that the level of chemical impurities in the drug product is under
specified levels. Peptides are an especially difficult compound to manufacture
at these standards, particularly at the scale at which Cytolex will be required
to be manufactured. Any contract manufacturers that the Company may use must
adhere to the Good Manufacturing Practices prescribed by the FDA.  Drug
manufacturing facilities must pass a plant inspection before the FDA will issue
approval to market a new drug product.  There can be no assurance that the
manufacturing information submitted for Cytolex, or other products under
development, will be sufficient for approval of the FDA.  

         Following extensive review of the NDA, the FDA may grant marketing
approval, require additional testing or information, or deny the application.
Sales of a new drug may commence following FDA approval of an NDA and
satisfactory completion of a pre-approval inspection of the manufacturing
facility, including a review of pertinent production records. If there are any
modifications to the drug, including any changes in indication, manufacturing
process, labeling or manufacturing facility, an NDA supplement may be required
to be submitted to the FDA. The FDA may also require post-marketing testing and
surveillance to monitor the effects of approved products or place conditions on
any approvals that could restrict the commercial applications of such products.
Product approvals may be withdrawn if compliance with regulatory standards is
not maintained or if problems concerning safety, efficacy or quality of the
product occur following approval.

         Continued compliance with all FDA requirements and conditions in an
approved application, including those concerning product specifications,
manufacturing process, validation, labeling, promotional material,
recordkeeping and reporting, is necessary for all approved drug products.
Failure to comply could result in Warning Letters, product recall or other
FDA-initiated actions, which could delay further marketing until the products
are brought into compliance.

         In October 1992, PDUFA was enacted, imposing substantial fees on a
one-time basis for applications for approval, and on an annual basis for the
manufacturing and marketing of prescription drugs. Legislation reauthorizing
PDUFA is currently pending in Congress and it is anticipated that such user
fees will continue and may increase in the future.

         The Company is also subject to regulation by other regulatory
authorities, including the Occupational Safety and Health Administration, the
Environmental Protection Agency, the Nuclear Regulatory Commission, the Drug
Enforcement Agency and the United States Department of Agriculture, and to
regulation under the





                                       19

<PAGE>   22
Toxic Substances Control Act, the Resource Conservation and Recovery Act and
other regulatory statutes, and may in the future be subject to additional
federal, state or local regulations. These agencies may promulgate regulations
that affect the Company's research and development programs.

         Sales of pharmaceutical products outside the United States are subject
to foreign regulatory requirements that vary widely from country to country.
Whether or not FDA approval has been obtained, approval by comparable
regulatory authorities of foreign countries must be obtained prior to the
commencement of marketing in those countries. The time required to obtain such
approval may be longer or shorter than that required for FDA approval. 

Patent and Proprietary Rights; Licensed Technology

         The Company's success will depend in part upon its ability to obtain
patent protection for compounds, uses of compounds, and processes. Patent
matters involve complex legal and factual issues, and can be highly uncertain.
Host defense compounds can be isolated from a wide variety of sources, and it
is not possible for the Company or any other entity to have proprietary rights
to all such compounds, or their uses. Additionally, chemical entities that are
similar to, but not identical with, the Company's compounds, may not be
protected by issued patents of the Company. In the genomics area, a number of
companies are attempting to rapidly identify and patent genes whose functions
have not yet been characterized. Additional companies are seeking to patent
fully characterized genes. The criteria for obtaining patent protection for
genes is unclear, and the impact of this uncertainty on the Company's business
can not be determined.

         The Company owns or has exclusive rights under license agreements to
45 issued patents, and an additional 26 patent applications are pending,
including the patent application relating to Cytolex. Of the 71 patents or
patent applications to which the Company has rights, 45 are related to host
defense and 26 are related to the Company's research efforts in genomics. There
can be no assurance that any patent applications now pending or filed in the
future will result in patents being issued or that any patents now held by or
licensed to the Company, or issued or licensed to the Company in the future,
will afford any competitive advantages for the Company, or will not be
challenged by third parties. The cost of litigation to uphold the validity and
prevent infringement of patents and to enforce licensing rights can be
substantial. Furthermore, there can be no assurance that others will not
independently develop similar technologies or duplicate the technology owned by
or licensed to the Company or design around the patented aspects of such
technology. In addition, there can be no assurance that the products and
technologies the Company will seek to market will not infringe patents or other
rights owned by others, licenses to which may not be available to the Company.

         The Company also relies upon unpatented proprietary technology, and
may determine in appropriate circumstances that its interest would be better
served by reliance on trade secrets or confidentiality agreements rather than
patents. There can be no assurance that others will not independently develop
substantially equivalent proprietary information and techniques or otherwise
gain access to such proprietary technology or that the Company can meaningfully
protect its rights in such unpatented proprietary technology. Additionally, if
the Company is unable to obtain strong proprietary rights protection of its
products after obtaining regulatory clearance, competitors may be able to
market competing products by obtaining regulatory clearance, through showing
equivalency to the Company's product, without being required to conduct the
lengthy clinical tests required to be conducted by the Company.

         Virtually all of the Company's key scientists worked at other
biotechnology or pharmaceutical companies or at universities and research
institutions before joining the Company. Disputes may arise as to whether
technology developed by such scientists while employed by or associated with
the Company was first discovered when they were employed by or associate with
others in a manner that would give third parties rights to such technology
superior to the rights, if any, of the Company. Disputes of this nature have
occurred in the past, and are expected to continue to arise in the future, and
there can be no assurance that the Company will prevail in any such disputes.
         
         To the extent that consultants, vendors or other third parties apply
technological information





                                       20

<PAGE>   23
independently developed by them or by others to the Company's proposed
products, disputes may arise as to the proprietary rights to such information,
which may not be resolved in favor of the Company.  Consultants to the Company
are employed by or have consulting agreements with third parties, and any
inventions discovered by such individuals are not likely to become the property
of the Company.

         The Company has rights under license agreements to certain patents and
patent applications under which the Company expects to owe royalties on sales
of any products which are covered by issued patent claims. Additionally,
certain of these agreements also provide that if the Company elects not to
pursue the commercial development of any licensed technology, or does not
adhere to an acceptable schedule of commercialization, then the Company's
exclusive rights to such technology would terminate.

Competition

         The pharmaceutical industry is characterized by intense competition.
Many companies, research institutions and universities are working in a number
of areas similar to the Company's field of interest. The Company is aware that
research is being conducted by others in connection with compounds from the
host-defense systems of various animals. Additionally, many companies are
involved in research and development activities focused on the pathogenesis of
disease, and competition among companies attempting to find the genes
responsible for disease is intense. Furthermore, many companies are engaged in
the development and sale of products, such as traditional antibiotics, which
may be, or are, competitive with the Company's proposed products. Most of these
entities have substantially greater financial, technical, manufacturing,
marketing, distribution and other resources than the Company. The Company's
proposed products may also be subject to competition from products using
techniques other than those developed by the Company or based on advances that
may render the Company's products obsolete.

         The Company expects technological developments in the
biopharmaceutical field to occur at a rapid rate and expects competition to
intensify as advances in this field are made. Accordingly, the Company will be
required to continue to devote substantial resources and efforts to research
and development activities in order to maintain a competitive position in this
field.  Compounds, products or processes developed by the Company may become
obsolete before the Company is able to recover a significant portion of its
research and development expenses. The Company will be competing with respect
to its proposed products with companies that have significantly more experience
in undertaking preclinical testing and human clinical trials of new or improved
therapeutic products and obtaining regulatory approvals of such products. Some
of these companies may be in advanced phases of clinical testing of various
drugs that may be competitive with the Company's proposed products.

         Colleges, universities, governmental agencies and other public and
private research organizations are becoming more active in seeking patent
protection and licensing arrangements to collect royalties for use of technology
that they have developed, some of which may be directly competitive with that of
the Company. In addition, these institutions, along with pharmaceutical and
specialized biotechnology companies, can be expected to compete with the Company
in recruiting highly qualified scientific personnel.

As to the disease areas being targeted by the Company, there can be no assurance
that Cytolex will be successfully marketed against oral antibiotics for the
treatment of infection in diabetic foot ulcers. These infections have
historically been treated with systemically administered antibiotics such as
ofloxacin, which may be perceived by some medical professionals as having
certain advantages over Cytolex. There also can be no assurance that Cytolex
can be manufactured at a cost which will allow it to be sold at a competitive
price relative to oral antibiotics, or other topical antibiotics that may be
used for this indication. Significant efforts are underway by many companies in
the development and marketing of products intended for the additional disease
areas being targeted by the Company, including cancer and asthma. A number of
major pharmaceutical companies have significant franchises in these disease
areas, and can be expected to invest heavily to protect these interests. In
addition, in the cancer field, anti-angiogenic agents are under development at
a number of companies. In the asthma field, other biopharmaceutical companies
have also reported the discovery of genes relating to asthma.      





                                       21

<PAGE>   24
EXECUTIVE OFFICERS OF THE COMPANY

The current executive officers of the Company are as follows:

<TABLE>
<CAPTION>
Name                                   Age         Position
----                                   ---         --------

<S>                                      <C>       <C>
Jay Moorin                               46        Chairman, President and Chief Executive Officer

Michael A. Zasloff, M.D., Ph.D.          52        Vice Chairman and Executive Vice President

Michael R. Dougherty                     40        Executive Vice President and Chief Financial Officer

Roy C. Levitt, M.D.                      44        Executive Vice President

Thomas J. Bigger                         41        Senior Vice President
</TABLE>



Mr. Moorin has served as President and Chief Executive Officer of the Company
since 1991. In July 1996, Mr. Moorin was appointed Chairman of the Board. Prior
to joining the Company, Mr. Moorin served as a Managing Director at Bear,
Stearns & Co., Inc. and was responsible for health care investment banking and
other services to the pharmaceutical and distribution industry. Mr. Moorin was
employed in other capacities by Bear, Stearns from 1988 to 1990. From 1983 to
1988, Mr. Moorin was employed by E. R. Squibb & Co., Inc. ("Squibb"), a
pharmaceutical company, joining Squibb as its first Corporate National Accounts
Director and subsequently was promoted to Business Area Director and Vice
President of Marketing and Business Development at SquibbMark, a division of
Squibb. Mr.  Moorin is a director of SunPharm Corp., and a special adjunct
fellow of the Leonard Davis Institute of Health Economics of the University of
Pennsylvania.

Dr. Zasloff has served as Executive Vice President of the Company and President
of the Magainin Research Institute, since July 1992.  In July 1996, Dr. Zasloff
was appointed Vice Chairman of the Board. From 1988 until Dr. Zasloff joined
the Company on a full-time basis in July 1992, Dr. Zasloff was the Company's
Chief Scientific Advisor and served as the Charles E.H. Upham Professor,
Department of Pediatrics and Genetics, University of Pennsylvania School of
Medicine, and Chief, Division of Human Genetics and Molecular Biology, The
Children's Hospital of Philadelphia. From 1982 until 1988, Dr. Zasloff was
Chief, Human Genetics Branch, National Institutes of Child Health and Human
Development, National Institutes of Health. Dr. Zasloff currently also serves
as Adjunct Professor, Department of Human Genetics and Orthopedics, University
of Pennsylvania School of Medicine.

Mr. Dougherty has served as Executive Vice President and Chief Financial
Officer of the Company since March 1995, and as a Director since August, 1997.
From August 1993, when he joined the Company, until March 1995, Mr. Dougherty
served as Senior Vice President and Chief Financial Officer. Prior to joining
the Company, Mr. Dougherty served in the following capacities at Centocor, Inc.
(a biopharmaceutical company): Senior Vice President, Chief Financial Officer
and Treasurer, from February 1992 to August 1993, Vice President Corporate
Finance from May 1990 to February 1992 and Treasurer from June 1986 to May
1990.

Dr. Levitt has served as Executive Vice President and the Director of the
Magainin Institute of Molecular Medicine since joining the Company in January
1996. Dr. Levitt was appointed head of Research and Development at the
Company, and a Director in August, 1997.  Prior to joining the Company, Dr.
Levitt was a faculty member at Johns Hopkins University in the Department of
Anesthesiology and Critical Care Medicine, from 1986 to 1995, in Neurological
Surgery from 1995 to 1996 and in Environmental Health Sciences from 1988 to
1996.





                                       22

<PAGE>   25
Mr. Bigger has served as Senior Vice President Business Development, Marketing
and Sales since joining the Company in July 1996.  Mr. Bigger served as Senior
Vice President of Advanced Polymer Systems (a drug development company), in
1994 and 1995.  From 1979 to 1994, Mr. Bigger held a number of positions of
increasing responsibility at Rhone-Poulenc Rorer ("RPR"), a pharmaceutical
company, including serving as President of Dermik Laboratories, a subsidiary of
RPR.


Officers are elected or appointed by the Board of Directors to serve until the
appointment or election and qualification of their successors or their earlier
termination or resignation.


EMPLOYEES

As of December 31, 1997, the Company had 72 full-time employees.  No employees
are covered by collective bargaining agreements, and the Company considers
relations with its employees to be good.





                                       23

<PAGE>   26
ITEM 2.          PROPERTIES.

         The Company occupies an aggregate of approximately 26,000 square feet
         of space in Plymouth Meeting, Pennsylvania, which is used as office
         and laboratory space.  The Company leases this space pursuant to
         leases expiring in 1999 and 2001, which provide for minimum annual
         payments of approximately $436,000 in the year ending December 31,
         1998 and are subject to increases on an annual basis for the remaining
         term.

ITEM 3.          LEGAL PROCEEDINGS

         The Company is not a party to any material litigation.

ITEM 4.          SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

         None.


PART II

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

         Magainin Pharmaceuticals Inc. common stock trades on the  Nasdaq Stock
Market under the symbol MAGN. The quarterly range of high and low closing sales
prices of the Company's common stock, as reported on the Nasdaq National Market,
are shown below.

<TABLE>
<CAPTION>
Year Ended
December 31, 1997         High    Low
-------------------------------------
<S>                       <C>     <C>
1st Quarter               $10.50  $7.88
2nd Quarter               $8.50   $6.63
3rd Quarter               $11.81  $7.25
4th Quarter               $12.13  $7.50
</TABLE>


<TABLE>
<CAPTION>
Year Ended
December 31, 1996         High    Low
-------------------------------------
<S>                       <C>     <C>
1st Quarter               $15.13  $10.25
2nd Quarter               $12.88  $8.38
3rd Quarter               $12.88  $7.50
4th Quarter               $12.13  $7.38
</TABLE>







                                       24

<PAGE>   27
DIVIDENDS
The Company has not paid any cash dividends since its inception and does not
anticipate paying any cash dividends in the foreseeable future. It is the
present policy of the Board of Directors to retain all earnings, if any, to
finance the development of the Company's business.

NUMBER OF HOLDERS OF COMMON STOCK
At March 5, 1998, there were approximately 338 stockholders of record and
approximately 4,300 beneficial holders of the Company's common stock.





                                       25

<PAGE>   28
ITEM 6.          SELECTED FINANCIAL DATA

The following table summarizes certain selected financial data. The selected
financial data is derived from, and is qualified by reference to, the financial
statements of the Company.

(In thousands, except per share amounts)


<TABLE>
<CAPTION>
 Year Ended December 31,           1997              1996            1995            1994         1993
 -----------------------           -------------------------------------------------------------------------
 <S>                               <C>               <C>             <C>             <C>          <C>
 STATEMENT OF OPERATIONS DATA:
 Revenues:
   Contract and government grant    $10,088          $    150        $  2,056        $    85      $    273
   Related party contract                --               ---             280            326           319
                                   -------------------------------------------------------------------------
                                     10,088               150           2,336            411           592
                                   -------------------------------------------------------------------------
 Costs and expenses:
   Research and development          22,875            22,326          18,160         11,258        11,455
   General and administrative         3,246             3,488           3,137          3,468         2,630
   Charge for stock insurance
      relating to royalty buyout         --             7,080             ---            ---           ---
                                   -------------------------------------------------------------------------
                                     26,121            32,894          21,297         14,726        14,085
                                   -------------------------------------------------------------------------
 Loss from operations               (16,033)          (32,744)        (18,961)       (14,315)     ( 13,493)
 Interest income                      1,770             2,172           1,778          1,207           846
 Interest expense                      (118)              (48)            (32)           (48)          (64)
                                   -------------------------------------------------------------------------
 Loss                              $(14,381)         $(30,620)       $(17,215)      $(13,156)     $(12,711)
 Loss per share - basic              $(0.73)         $  (1.71)       $  (1.17)      $   (.99)     $  (1.14)
                                   =========================================================================
 Weighted average shares
 outstanding                         19,679            17,938          14,696         13,301        11,108

 December 31,                         1997              1996            1995           1994          1993
 ------------                      -------------------------------------------------------------------------
 BALANCE SHEET DATA:
 Cash and investments               $39,061           $ 33,340       $ 43,666        $25,921       $38,303
 Working capital                     33,073             28,276         30,429         21,750        30,621
 Total assets                        42,444             36,376         45,727         28,050        40,460
 Long-term liabilities                1,096                915            304            460           299
 Total liabilities                    7,574              6,433          4,534          4,137         3,451
 Accumulated deficit               (109,624)           (95,243)       (64,623)       (47,408)      (34,252)
 Stockholders' equity                34,870             29,943         41,193         23,913        37,009
</TABLE>





                                       26

<PAGE>   29
ITEM 7.          MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
                 AND FINANCIAL CONDITION

         This report contains, in addition to historical information,
         statements by the Company with regard to its expectations as to
         financial results and other aspects of its business that involve risks
         and uncertainties and may constitute forward looking statements within
         the meaning of the Private Securities Litigation Reform Act of 1995.
         Such statements reflect management's current views and are based on
         certain assumptions.  Actual results could differ materially from
         those currently anticipated as a result of a number of factors,
         including, but not limited to, the risks and uncertainties discussed
         in this report, as well as those discussed under "Risk Factors" set
         forth in Item 1 of the Company's Annual Report on Form 10-K for the
         fiscal year ended December 31, 1997, as filed with the Securities and
         Exchange Commission.  Given these uncertainties, current or
         prospective investors are cautioned not to place undue reliance on any
         such forward-looking statements.  Furthermore, the Company disclaims
         any obligation or intent to update any such factors or forward looking
         statements to reflect future events or developments.

GENERAL

The Company is a biopharmaceutical company engaged in the development of
medicines for serious diseases.  The Company has completed two pivotal Phase
III clinical trials for its lead product development candidate, Cytolex, a
topical cream antibiotic intended for the treatment of infection in diabetic
foot ulcers.  The Company is also conducting research on an aminosterol class
of compounds.  One such compound, squalamine, is being evaluated in Phase I
clinical testing in cancer.  The Company's newest research efforts are in the
genomics of asthma.

Since commencing operations in 1988, the Company has not generated any sales
revenue.  The Company has funded operations primarily from the proceeds of
public and private placements of securities.  The Company has incurred net
losses in each year since its inception, and expects to incur substantial
additional losses for at least the next several years.  The Company expects
that losses will fluctuate from quarter to quarter, and that such fluctuations
may be substantial.   At December 31, 1997, the Company's accumulated deficit
was $109,624,000.

As a result of revenues earned during the year ended December 31, 1997, the
Company is no longer in the development stage.


RESULTS OF OPERATIONS

REVENUES

The Company has received no revenue from product sales.  Revenues recorded to
date have consisted principally of revenues recognized under collaborative
arrangements with corporate partners.  The Company recorded revenues of
$10,000,000 in 1997 reflecting the receipt of payments under the Development,
Supply and Distribution Agreement entered into in February 1997 with SmithKline
Beecham ("SB") for Cytolex.  Contract revenues of $88,000, $150,000 and
$150,000 in 1997, 1996 and 1995, respectively, consist of payments under a
collaborative arrangement with Abbott Laboratories ("Abbott") in the
nutritional field.  The Company recorded revenues of $1,900,000 in 1995
relating to the execution of an Agreement in Principle with Fisons plc in
September 1995, and the termination of this arrangement in November 1995.
Related party contract revenue consisted of funding received from
Colgate-Palmolive Company pursuant to an oral health care collaboration which
concluded in January 1996.

The Company does not expect to realize additional milestone revenues from its
arrangement with SB until FDA approval of Cytolex.  However, there can be no
assurance that Cytolex will be approved by the FDA.  The





                                       27

<PAGE>   30
Company has no other currently existing collaborations which will result in the
realization of research and development revenues.


RESEARCH AND DEVELOPMENT EXPENSES

Research and development expenses increased on an annual basis from 1995
through 1997 principally as a result of increases in manufacturing development
expenses, clinical and pre-clinical testing, personnel costs, and laboratory
supplies expense.  In particular, these increases have been related to
increasing costs associated with the Company's lead product candidate, Cytolex.
Expenses have also increased due to pre-clinical activities associated with the
Company's other research and development programs, including its aminosterol
and asthma genomics programs.

Significant development work is necessary to scale-up the manufacturing process
for the Company's products to those levels necessary for a profitable
commercial product.  The Company contracts with third parties for these
manufacturing development activities, and for the procurement of material for
clinical and pre-clinical testing, and such expenses, including those for
Cytolex, amounted to $10,174,000, $9,557,000 and $7,652,000 in 1997, 1996 and
1995, respectively.

The Company contracts with third parties to conduct its clinical trial
programs.  In 1994, the Company initiated a pivotal clinical trial of Cytolex
for the treatment of infection in diabetic foot ulcers, and a second trial was
initiated in 1995.  Clinical trial and regulatory contract costs amounted to
$1,761,000, $4,005,000, and $5,172,000 in 1997, 1996 and 1995, respectively.

The level of research and development expenses in future periods will depend
upon the success of the Cytolex development program, and the progress of other
research programs at the Company.  Expenses relating to the development of
Cytolex are expected to continue to be significant in future periods principally
as a result of the Company's ongoing manufacturing development program,
partially offset by a decline in clinical trial costs related to Cytolex.  The
Company expects to finalize an agreement with Abbott for the purchase of bulk
drug substance for Cytolex in 1998, prior to any FDA approval of Cytolex,
resulting in significant research and development expenses in 1998.  The Company
also expects, in future periods, increased development expenses relating to its
aminosterol and asthma genomics programs.

GENERAL AND ADMINISTRATIVE EXPENSES

General and administrative expenses have consisted principally of personnel
costs and professional fees, and have fluctuated year to year from 1995 through
1997 due largely to changes in professional fees expense.  The Company expects
general and administrative expenses to increase in future periods as the
Company's level of activities increase.

OTHER EXPENSES/INCOME

The Company recorded a charge to earnings of $7,080,000 in 1996 principally
representing the fair value of 550,000 shares of Common Stock issued by the
Company in a buyout of royalties which the Company would otherwise have owed on
any sales of Cytolex.

The decrease in interest income in the year ended December 31, 1997 as compared
to the same period a year ago is principally due to decreased investment
balances.  The increase in interest income in 1996 over 1995 is due principally
to increasing investment balances and higher prevailing interest rates.

Interest expense consists primarily of interest under the Company's credit
facility, and the interest component of equipment capital lease obligations. In
late 1996 and early 1997, the Company borrowed $1,500,000 under its credit
facility, resulting in increased interest expense in the year ended December 31,
1997 as compared to the same period a year ago.





                                       28

<PAGE>   31
LOSS

The Company expects to conduct, over the next several years, significant
research, pre-clinical development, clinical testing and manufacturing
development activities which, together with projected general and
administrative expenses, are expected to result in continued and significant
losses, particularly due to the extended time period before the Company expects
to commercialize any products.

FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES

Cash and investments were approximately $39,061,000 at December 31, 1997 as
compared to $33,340,000 at December 31, 1996.  Cash used in operating
activities was $12,666,000, $21,831,000 and $14,953,000 in 1997, 1996 and 1995,
respectively.

Since inception, the Company has funded its operations primarily from the
proceeds of public and private placements of securities, including $17,080,000
raised from its initial public offering in December 1991, $21,469,000 raised
from a public offering completed in February 1993, $18,023,000 raised from a
private placement of Common Stock completed in October 1993, $32,627,000 raised
from a public offering completed in August 1995, $11,932,000 raised from a
private placement completed in August 1996 and $19,172,000 raised from a public
offering completed in December 1997, as well as contract and grant revenues,
interest income and lease and debt financing.

Capital expenditures were $1,294,000 in 1997, principally reflecting equipment
purchases.  Capital expenditures were $1,655,000 in 1996, principally
reflecting an expansion of the Company's leased facility.

Accounts payable and accrued expenses were $5,944,000 at December 31, 1997, an
increase of $799,000 over December 31, 1996, primarily as a result of increases
in amounts owed under clinical and regulatory contract arrangements.  The
Company expects an increase in accounts payable and accrued expenses in future
periods as costs for the purchase of bulk drug substance are accrued in 1998,
but not paid until late 1998 and 1999. During 1997, the Company borrowed an
additional $500,000 under a credit facility, resulting in an increase in note
payable.

In February 1997, the Company entered into a Development, Supply and
Distribution Agreement (the "Agreement") in North America with SB for Cytolex.
SB has paid the Company $10,000,000 under this Agreement, and may make
additional payments to Magainin of up to $22,500,000 upon the occurrence of
certain product milestones.  SB will also fund a percentage of any development
expenses for any additional indications for Cytolex.  Upon the commencement of
commercial sales by SB, Magainin will be responsible for the supply of Cytolex
and SB will be responsible for the marketing and sales of Cytolex.  Magainin
will receive certain percentages of SB sales revenues under agreed upon terms.
The Agreement also gives SB the right to negotiate for rights to another
Magainin product development candidate, under certain terms and conditions.

In September 1996, the Company announced results of its initial pivotal trial
of Cytolex for the treatment of infection in diabetic foot ulcers, and in March
1997 the Company reported results from a second such pivotal trial. The
clinical trials conducted for Cytolex yielded substantial data. Such data
includes information relating to the primary endpoint for the studies (clinical
cure or improvement of infection), as well as additional data relating to
microbiological results, wound healing and side effects.  Analyses were done on
various aspects of the data, and various patient subgroups, some of which
yielded results that favored ofloxacin.  Additionally, the Company is
continuing its analyses of data from the studies.  There can be no assurance
that such continued analyses will yield positive results.  Although the Company
believes the two pivotal trials of Cytolex yielded successful results, there
can be no assurance that the FDA will concur with the Company's analysis in
this regard.  There can be no assurance that Cytolex will receive FDA approval
on a timely basis, if at all. The failure of the Company to obtain FDA approval
for Cytolex, any significant delay in obtaining such approval, or the
imposition of highly restrictive conditions on such approval, would have a
material adverse effect on the Company.





                                       29

<PAGE>   32
The Company believes that its existing capital resources should be sufficient
to finance its operations through 1999.  However, the Company's capital
requirements may change due to numerous factors, including the progress of the
Company's research and development programs, regulatory approvals, competitive
and technological advances, the commercial viability of the Company's products,
the terms of collaborative arrangements, if any, entered into by the Company,
and other factors, many of which are beyond the Company's control.  The Company
will require substantial additional funds to continue its research and
development programs and to commercialize potential products. The Company
intends to seek such funds through a combination of future offerings of
securities and collaborative arrangements with third parties, and regularly
explores alternatives in this regard.  The Company does not have any
commitments to obtain any additional funds and has no established banking
arrangements through which it can obtain additional debt financing.  There can
be no assurance that future funding will be available to the Company or, if
available, will be obtainable on terms favorable to the Company.  The receipt
of funding, if any, from any corporate partners, including SB, will depend
largely on the progress of research and development programs.  Under
collaborative arrangements, the Company may convey marketing, distribution,
manufacturing, development or other rights to its proposed products to
pharmaceutical companies in order to receive financial or other assistance.
This will result in lower consideration to the Company upon commercialization
of such products than if no arrangements were entered into or if such
arrangements were entered into at later stages in the product development
process.  There can be no assurance that the Company will be able to enter into
such arrangements on favorable terms, if at all.

If the Company does not enter into appropriate collaborations, receive
additional funds from SB under its current agreement or raise sufficient funds
from the periodic sale of securities, the Company will be required to delay or
eliminate expenditures for potential products, including Cytolex, or to enter
into collaborations with third parties to commercialize potential products or
technologies that the Company would otherwise seek to develop itself, or seek
other arrangements.

The Company is working with Abbott with regard to the development by Abbott of
a solution phase chemical process to manufacture bulk drug substance for
Cytolex on a commercial scale.  The Company is currently dependent upon Abbott
for the production of bulk drug substance for Cytolex.  In the event that bulk
drug substance for Cytolex is not manufactured at Abbott, the Company will need
to secure other manufacturing arrangements.  The process developed by Abbott is
proprietary, and in the event the Company desires to utilize, or have another
party utilize, such proprietary technology, the Company would be required to
make license payments to Abbott.  Further progress in scale-up and
manufacturing development efforts will be required to enable the Company to
manufacture and sell Cytolex on a profitable basis.  This may require
substantial additional funds.  The Company has certain efforts under way with
respect to alternative manufacturing sources, including recombinant
manufacturing; however, these programs are at an early stage, and significant
expenditures over an extended period of time will be required to develop a
commercially viable process.  No assurance can be given that a cost-effective
manufacturing process can ultimately be developed, or that any such process
would be approved by the FDA, or that the Company, Abbott or others will be
able to manufacture Cytolex on a commercially viable basis.

The Company's arrangement with Abbott also provides for the issuance by the
Company to Abbott of up to 500,000 shares of its Common Stock and the
obligation to pay a royalty on any future sales of Cytolex.  Stock issuances by
the Company to Abbott will result in a charge to earnings, representing the
fair value of the shares when issued.  The Company issued 125,000 shares of
common stock to Abbott in October 1995, resulting in a charge to earnings of
$1,250,000 in 1995.  Future stock issuances are related to the achievement by
Abbott of contractual performance milestones.

The Company expects to contract with Abbott for the purchase of bulk drug
substance for Cytolex in 1998, prior to any FDA approval of Cytolex, resulting
in significant research and development expenses in 1998.

The Company also expects to conduct significant manufacturing development
activities for its other products under development.  The Company is currently
working with outside contractors for the chemical production of squalamine.
The Company expects to expend significant resources in the production of
squalamine and any





                                       30

<PAGE>   33
other compounds under development, and there can be no assurance that these
efforts will be successful.

The Company's capital expenditure requirements will depend upon numerous
factors, including the success of Cytolex and the progress of the Company's
other research and development programs, the time and cost required to obtain
regulatory approvals, the ability of the Company to enter into additional
collaborative arrangements, the demand for products based on the Company's
technology, if and when such products are approved, and possible acquisitions
of products, technologies and companies.  The Company had no significant
capital commitments as of December 31, 1997.


ITEM 7A         QUANTITATIVE DISCLOSURES ABOUT MARKET RISK.
      
         Not Applicable.


ITEM 8.          FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

         The information required by this item is set forth beginning on page
         F-1 hereof in the Table of Contents for  PART II - Financial
         Information.

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

         None.





                                       31

<PAGE>   34

PART III

ITEM 10.         DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT


         Information required by this item concerning directors is incorporated
         herein by reference from the Company's Proxy Statement for the 1998
         Annual Meeting of Shareholders.  Set forth in Part I - Item 1 is the
         information required by this item concerning executive officers.


ITEM 11.         EXECUTIVE COMPENSATION.

         Information required by this item is incorporated herein by reference
         from the Company's Proxy Statement for the 1998 Annual Meeting of
         Shareholders.

ITEM 12.         SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
                 MANAGEMENT.

         Information required by this item is incorporated herein by reference
         from the Company's Proxy Statement for the 1998 Annual Meeting of
         Shareholders.

ITEM 13.         CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         None.


PART IV

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

Financial Statements

         The information required by this item is set forth in the Table of 
         Contents to Financial Statements on page F-1 hereof.

Financial Statement Schedules

         All schedules have been omitted because they are not applicable, or
         not required, or the information is shown in the Financial Statements
         or Notes thereto.

Reports on Form 8-K

         None.





                                       32

<PAGE>   35
Exhibits

         The following is a list of exhibits filed as part of this Annual
Report on Form 10-K.  Where so indicated by footnote, exhibits which were
previously filed are incorporated by reference.  For exhibits incorporated by
reference, the location of the exhibit in the previous filing is indicated
parenthetically, together with a reference to the filing indicated by footnote.


<TABLE>
<CAPTION>
Exhibit No.
-----------
   <S>     <C>           <C>
     3.1                 Restated Certificate of Incorporation of the Registrant (Exhibit 3.1)(1)

     3.2                 Certificate of Amendment of Restated Certificate of Incorporation of the Registrant (Exhibit 3.2)(13)

     3.3                 By-laws of the Registrant (Exhibit 3.2)(2)

     4.1                 Specimen copy of stock certificate for shares of Common Stock of the Registrant (Exhibit 4.1) (3)

    10.1   #             1990 Stock Option Plan of the Registrant (Exhibit 10.1) (2)
          
    10.2   #             1992 Stock Option Plan of the Registrant, as amended (4)
          
    10.3   #             Stock Option Agreement with Jay Moorin (Exhibit 10.24) (3)
          
    10.4   #             Amendment to Stock Option Agreement with Jay Moorin (Exhibit 10.4) (1)
          
    10.5   #             Form of Stock Option Agreement under Stock Option Plans (Exhibit 4.6) (2)
          
    10.6   #             Employment Agreement with Jay Moorin (Exhibit 10.2) (2)
                 
    10.7   #             Employment Agreement with Michael A. Zasloff (Exhibit 10.23) (3)
          
    10.8   #             Amendment of Employment Agreement with Michael A. Zasloff (Exhibit 10.9) (3)
          
    10.9   #             Employment Agreement with Michael R. Dougherty (Exhibit 10.26) (7)

   10.10   #             Employment Agreement with Roy C. Levitt, M.D. (Exhibit 10.24) (5) (9)


   10.11   #             Employment Agreement with Thomas J. Bigger (Exhibit 10.12)(13)

   10.12                 Lease with respect to Plymouth Meeting, Pennsylvania offices and laboratories (Exhibit 10.16) (2)

   10.13   *             Lease with respect to Plymouth Meeting, Pennsylvania office

   10.14                 Patent License Agreement and Sponsored Research Agreement with The Children's Hospital of Philadelphia
                         (Exhibit 10.15)(2)

   10.15                 License Agreement with Multiple Peptide Systems, Inc. (Exhibit 10.12)(2)
</TABLE>





                                       33

<PAGE>   36

<TABLE>
<CAPTION>
 Exhibit No.
 -----------

   <S>       <C>
   10.16     Second Amendment to License Agreement with Multiple Peptide Systems, Inc. (Exhibit 10.30) (12)

   10.17     Stock Issuance Agreement between the Company and The Scripps Research Institute.  (Exhibit 10.2) (11)

   10.18     Stock Issuance Agreement between the Company and Houghten Pharmaceuticals, Inc. (Exhibit 10.1)(11)

   10.19     Form of Credit Agreement, including form of Promissory Note and Warrant (Exhibit 10.22) (2)

   10.20     Form of Amendment to Credit Agreement Warrant (Exhibit 10.18) (6)

   10.21     Research and Development Agreement with Abbott Laboratories (Exhibit 10.23)(7)

   10.22     Warrant Agreement with Abbott Laboratories (Exhibit 10.25)(7)

   10.23     Manufacturing Agreement with Abbott Laboratories, dated October 4, 1995 (Exhibit 10.27)(5)(8)

   10.24     Stock Issuance Agreement with Abbott Laboratories, dated October 4, 1995 (Exhibit 10.28)(5)(8)

   10.25     Assignment Agreement between Magainin Pharmaceuticals Inc., Roy C. Levitt, M.D. and GeneQuest, Inc. (Exhibit 10.25)
             (5)(9)

   10.26     Form of Purchase Agreement relating to the issuance by the Company of units consisting of shares of the Company's
             Common Stock and warrants to purchase shares of the Company's Common Stock. (Exhibit 10.1)(10)

   10.27     Form of Warrant to purchase shares of the Company's Common Stock.  (Exhibit 10.2)(10)

   10.28     Development, Supply and Distribution Agreement, effective as of February 12, 1997 with SmithKline Beecham Corporation
             (Exhibit 10.29)(5)(13)


   23     *  Consent of Richard A. Eisner & Company, LLP

   24     *  Power of Attorney (included on signature page of this Annual Report on Form 10-K)

   27     *  Financial Data Schedule

</TABLE>





                                       34
<PAGE>   37

-------------------
Explanation of Footnotes to Listing of Exhibits

<TABLE>
<S>         <C>
       *     Filed herewith.

       #     Compensation plans and arrangements for executives and others.

     (1)     Filed as an Exhibit to the Annual Report on Form 10-K for the year ended June 30, 1992 filed with the Securities and
             Exchange Commission on September 24, 1992.

     (2)     Filed as an Exhibit to Registration Statement (No. 33-43579) on Form S-1 filed with the Securities and Exchange
             Commission on October 24, 1991.

     (3)     Filed as an Exhibit to Pre-Effective Amendment No. 1 to Registration Statement (No. 33-43579) on Form S-1 filed with
             the Securities and Exchange Commission on November 27, 1991.

     (4)     Filed as Exhibit A to the Company's Proxy Statement for the 1996 Annual Meeting of Stockholders.

     (5)     Portions of this Exhibit were omitted and filed separately with the Securities and Exchange Commission pursuant to an
             order granting confidential treatment.

     (6)     Filed as an Exhibit to the Transition Report on Form 10-K for the year ended December 31, 1993 filed with the
             Securities and Exchange Commission on March 9, 1994.

     (7)     Filed as an Exhibit to the Annual Report on Form 10-K for the year ended December 31, 1994 filed with the Securities
             and Exchange Commission on March 31, 1995.

     (8)     Filed as an Exhibit to the Form 10-Q for the quarter ended September 30, 1995 filed with the Securities and Exchange
             Commission on November 9, 1995.

     (9)     Filed as an Exhibit to the Annual Report on Form 10-K for the year ended December 31, 1995 filed with the Securities
             and Exchange Commission on March 29, 1996.

    (10)     Filed as an Exhibit to Registration Statement (No. 333-9927) on Form S-3 filed with the Securities and Exchange
             Commission on August 9, 1996.
         
    (11)     Filed as an Exhibit to Registration Statement (No. 333-14555) on Form S-3 filed with the Securities and Exchange
             Commission on October 21, 1996.
         
    (12)     Filed as an Exhibit to the Form 10-Q for the quarter ended September 30, 1996 filed with the Securities and Exchange
             Commission on November 14, 1996.
         
    (13)     Filed as an Exhibit to the Annual Report on Form 10-K for the year ended December 31, 1996 filed with the Securities
             and Exchange Commission on March 31, 1997.
</TABLE>





                                       35

<PAGE>   38
                                   SIGNATURES

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

                         MAGAININ PHARMACEUTICALS INC.

Date: March 6, 1998              By: /s/ Jay Moorin
                                    ----------------
                                 Jay Moorin
                                 Chairman, President and Chief Executive Officer

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

         Each person whose signature appears below in so signing also makes,
constitutes and appoints Jay Moorin, Chairman, President and Chief Executive
Officer, and Michael R. Dougherty, Executive Vice President and Chief Financial
Officer, and each of them severally, his true and lawful attorney-in-fact, in
his name, place and stead to execute and cause to be filed with the Securities
and Exchange Commission any or all amendments to this report.

<TABLE>
<CAPTION>
      Signature                         Title                                                     Date
      ---------                         -----                                                     ----

<S>                                     <C>                                              <C>
/s/ Jay Moorin                          Chairman, President and Chief                    March 6, 1998
-------------------------               Executive Officer and Director
Jay Moorin                              (Principal Executive Officer)


/s/ Michael A. Zasloff, M.D. Ph. D.     Vice Chairman, Executive Vice                    March 6, 1998
-----------------------------------     President and Director
Michael A. Zasloff, M.D., Ph.D.

/s/ Michael R. Dougherty                Executive Vice President and                     March 6, 1998
------------------------                Chief Financial Officer, and Director
Michael R. Dougherty                    (Principal Financial and Accounting Officer)

/s/ Roy C. Levitt, M.D.                 Executive Vice President and                        March 6, 1998
-----------------------                 Head of Research and Development
Roy C. Levitt, M.D.                     and Director

/s/ Bernard Canavan, M.D.               Director                                         March 6, 1998
-------------------------
Bernard Canavan, M.D.

/s/ Zola P. Horovitz, Ph. D.            Director                                         March 6, 1998
----------------------------
Zola P. Horovitz, Ph.D.

/s/ Charles A. Sanders, M.D.            Director                                         March 6, 1998
----------------------------
Charles A. Sanders, M.D.

/s/ Robert F. Shapiro                   Director                                         March 6, 1998
---------------------
Robert F. Shapiro

                                        Director                                         
-------------------------
James B. Wyngaarden, M.D.
</TABLE>





                                       36

<PAGE>   39
                         MAGAININ PHARMACEUTICALS INC.

                               Table of Contents

                        PART II - Financial Information

<TABLE>
<CAPTION>
ITEM 8.          FINANCIAL STATEMENTS
                                                                                          Page
                                                                                          ----

         <S>                                                                              <C>
         Report of Independent Auditors                                                   F-2


         Balance Sheets                                                                   F-3


         Statements of Operations                                                         F-4


         Statements of Changes in Stockholders' Equity                                    F-5


         Statements of Cash Flows                                                         F-6


         Notes to Financial Statements                                                    F-7
</TABLE>





                                      F-1

<PAGE>   40
                         REPORT OF INDEPENDENT AUDITORS



Board of Directors and Stockholders
Magainin Pharmaceuticals Inc.
Plymouth Meeting, Pennsylvania


We have audited the accompanying balance sheets of Magainin Pharmaceuticals
Inc. as at December 31, 1997, and December 31, 1996 and the related statements
of operations, changes in stockholders' equity and cash flows for each of the
years in the three-year period ended December 31, 1997.  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 enumerated above present fairly, in
all material respects, the financial position of Magainin Pharmaceuticals Inc.
at December 31, 1997 and December 31, 1996 and the results of its operations
and its cash flows for each of the years in the three-year period ended
December 31, 1997, in conformity with generally accepted accounting principles.



Richard A. Eisner & Company, LLP
New York, New York
February 6, 1998





                                      F-2

<PAGE>   41


BALANCE SHEETS                                     Magainin Pharmaceuticals Inc.
(In thousands, except per share amounts)




<TABLE>
<CAPTION>
December 31,                                                          1997           1996
------------                                                          ----           ----


<S>                                                              <C>             <C>
ASSETS
Current assets:
  Cash and cash equivalents                                       $     487      $  2,072
  Short-term investments                                             38,574        31,268
  Prepaid expenses and other current assets                             490           454
                                                                  ---------      --------
        Total current assets                                         39,551        33,794
Fixed assets, net                                                     2,824         2,506
Other assets                                                             69            76
                                                                  ---------      --------
             Total assets                                         $  42,444      $ 36,376
                                                                  =========      ========
LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
  Accounts payable and accrued expenses                           $   5,944      $  5,145
  Note payable - current                                                500           250
  Equipment lease obligations - current                                  34           123
                                                                  ---------      --------
        Total current liabilities                                     6,478         5,518
Note payable - long-term                                              1,000           750
Equipment lease obligations - long-term                                   -            38
Deferred rent                                                            96           127
                                                                  ---------      --------
        Total liabilities                                             7,574         6,433
                                                                  ---------      --------

Commitments, contingencies and other matters

Stockholders' equity:
Preferred stock - $.001 par value; shares
  authorized - 9,211; none issued
Common stock - $.002 par value; shares
  authorized - 45,000; shares issued and
  outstanding - 21,980 and 19,364                                        44            39
Additional paid-in capital                                          144,444       125,134
Unrealized gain on investments                                            6            13
Accumulated deficit                                                (109,624)      (95,243)
                                                                  ---------      --------
        Total stockholders' equity                                   34,870        29,943
                                                                  ---------      --------
  Total liabilities and stockholders' equity                      $  42,444      $ 36,376
                                                                  =========      ========
</TABLE>


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





                                      F-3

<PAGE>   42


 STATEMENTS OF OPERATIONS             Magainin Pharmaceuticals Inc.
 (In thousands, except per share
 amounts)




<TABLE>
<CAPTION>
 YEAR ENDED DECEMBER 31,                1997            1996            1995
 -----------------------                ----            ----            ----


 <S>                                    <C>            <C>              <C>
 REVENUES:
   Contract                               $ 10,088      $    150         $  2,056
   Related party contract                       --            --              280
                                          --------      --------         --------
                                            10,088           150            2,336
                                          --------      --------         --------
 COSTS AND EXPENSES:
   Research and development                 22,875        22,326           18,160
   General and administrative                3,246         3,488            3,137
   Charge for stock issuance relating           --         7,080               --
        to royalty buyout                 --------      --------         --------

                                            26,121        32,894           21,297
                                          --------      --------         --------
 Loss from operations                      (16,033)      (32,744)         (18,961)
 Interest income                             1,770         2,172            1,778
 Interest expense                             (118)          (48)             (32)
                                          --------      --------         --------
 Loss                                     $(14,381)     $(30,620)        $(17,215)
                                          ========      ========         ========
 Loss per share - basic                     $(0.73)       $(1.71)          $(1.17)
                                          ========      ========         ========
 Weighted average shares outstanding        19,679        17,938           14,696
                                          ========      ========         ========
</TABLE>


 The accompanying notes are an integral part of these financial statements





                                      F-4

<PAGE>   43


STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY      Magainin Pharmaceuticals Inc.
(In thousands)



<TABLE>
<CAPTION>
                                            Common Stock
                                                                                                 Unrealized
                                                                      Additional                    Gain
                                         Number                        Paid-in     Accumulated    (Loss) on
                                        of Shares      Amount          Capital       Deficit     Investments
                                        ---------      ------          -------       -------     ----------
<S>                                       <C>       <C>               <C>        <C>            <C>
BALANCE AT JANUARY 1, 1995                 13,320   $      27         $ 71,463    $(47,408)     $    (169)
Common stock issued pursuant to public      3,500           7           32,620           --
  offering
Common stock issued, exercise of              107          --              329           --
  options
Fair value of shares issued to                125          --            1,250           --
  contract manufacturer
Carrying value adjustment                      --          --               --           --            289
Loss                                           --          --               --     (17,215)             --
                                        ---------   ---------       ----------   ----------         ------
BALANCE AT DECEMBER 31, 1995               17,052          34          105,662     (64,623)            120

Common stock issued pursuant to             1,557           3           11,929           --             --
  private placement
Fair value of shares issued pursuant          550           1            7,059           --             --
  to royalty buyout
Common stock issued, exercise of              205           1              484           --             --
  options and warrants
Carrying value adjustment                      --          --               --           --          (107)
Loss                                           --          --               --     (30,620)             --
                                        ---------   ---------        ---------   ----------         ------
BALANCE AT DECEMBER 31, 1996               19,364          39          125,134     (95,243)             13
Common stock issued pursuant to public      2,587           5           19,167
  offering
Common stock issued, exercise of               29                          143
  options and warrants
Carrying value adjustment                                                                              (7)
Loss                                           --          --               --     (14,381)             --
                                        ---------   ---------         --------   ----------         ------
BALANCE AT DECEMBER 31, 1997               21,980         $44         $144,444   ($109,624)             $6
                                        =========   =========         ========   ==========         ======
</TABLE>



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





                                      F-5

<PAGE>   44

STATEMENTS OF CASH FLOWS              Magainin Pharmaceuticals Inc.
(IN THOUSANDS)


<TABLE>
<CAPTION>
 YEAR ENDED DECEMBER 31,                          1997          1996         1995
 -----------------------                          ----          ----         ----
 <S>                                             <C>           <C>          <C>
 CASH FLOWS FROM OPERATING ACTIVITIES:
   Loss                                          $(14,381)     $(30,620)    $(17,215)
   Adjustments to reconcile loss to net
        cash used in operating activities:
        Fair value of stock, options and                
        warrants issued                                 --         7,060        1,250
    Depreciation and amortization                      976           625          456
    Deferred rent                                     (31)          (16)          (6)
    Changes in operating assets and
      liabilities:
      (Increase) decrease in prepaid                  
         expenses and other assets                    (29)            55         (28)
      Increase in accounts payable                                                    
         and accrued expenses                          799         1,065          590 
                                                 ---------     ---------    --------- 

 Net cash used in operating activities            (12,666)      (21,831)     (14,953)
                                                 ---------     ---------    ---------
 CASH FLOWS FROM INVESTING ACTIVITIES:
   Purchase of investments                        (73,065)      (28,019)     (62,948)
   Proceeds from maturities and                     
    sales of investments                            65,752        38,430       44,821
   Capital expenditures                            (1,294)       (1,655)        (360)
                                                 ---------     ---------    ---------
 Net cash provided by (used in)                                                       
   investing activities                            (8,607)         8,756     (18,487) 
                                                 ---------     ---------    --------- 

 CASH FLOWS FROM FINANCING ACTIVITIES:
   Proceeds from notes payable                         500         1,000           --
   Payments on capitalized equipment leases          (127)         (150)        (186)
   Proceeds from sale of stock and exercise                                           
    of options and warrants                         19,315        12,417       32,956                                      
                                                 ---------     ---------    ---------                                      

 Net cash provided by financing activities          19,688        13,267       32,770
                                                 ---------     ---------    ---------
 Net increase (decrease) in cash and             
   cash equivalents                                (1,585)           192        (670)
 Cash and cash equivalents at beginning                                              
   of period                                         2,072         1,880        2,550
                                                 ---------     ---------    ---------
 Cash and cash equivalents at end of period      $     487     $   2,072    $   1,880
                                                 =========     =========    =========

 SUPPLEMENTAL CASH FLOW INFORMATION:
 Cash paid during the period for interest        $     106     $      48    $      32
                                                 =========     =========    =========
</TABLE>



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





                                      F-6

<PAGE>   45

NOTES TO FINANCIAL STATEMENTS                      Magainin Pharmaceuticals Inc.


1.  THE COMPANY:

Magainin Pharmaceuticals Inc. (the "Company") was incorporated on June 29,
1987.  The Company is a biopharmaceutical company engaged in the development of
medicines for serious diseases.  The Company has completed two pivotal Phase
III clinical trials for its lead product development candidate, Cytolex, a
topical cream antibiotic intended for the treatment of infection in diabetic
foot ulcers.  The Company is also conducting research on an aminosterol class
of compounds.  One such compound, squalamine, is being evaluated in Phase I
clinical testing in cancer.  The Company's newest research efforts are in the
genomics of asthma.

The Company has not generated any revenues from product sales, and has funded
operations primarily from the proceeds of public and private placements of
securities.  Substantial financing will be required by the Company to fund its
research and development activities.  There can be no assurance that such
financing will be available when needed or that the Company's research and
development efforts will be successful.

As a result of revenues earned during the year ended December 31, 1997, the
Company is no longer in the development stage.

2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

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 amounts reported in the financial statements
and related notes.  Actual results could differ from those estimates.

Cash and Cash Equivalents - The Company considers all highly liquid investment
instruments purchased with a maturity of three months or less to be cash
equivalents.

Investments - Investments purchased with a maturity of more than three months,
and which mature less than twelve months from the balance sheet date, are
classified as short-term investments.  Long-term investments are those with
maturities greater than twelve months from the balance sheet date.  The Company
generally holds investments to maturity, however, since the Company may, from
time to time, sell securities to meet cash requirements, the Company classifies
its investments as available-for-sale as defined by Statement of Financial
Accounting Standard No. 115, "Accounting for Certain Investments in Debt and
Equity Securities" ("SFAS 115").  Available-for-sale securities are carried at
market value with unrealized gains and losses reported as a separate component
of Stockholders' Equity.  Gross realized gains and losses on the sales of
investment securities are determined on the specific identification method and
are included in interest income.

Fixed Assets and Depreciation - Fixed assets are recorded at cost and
depreciated using the straight-line method over the estimated useful lives of
the assets.  Equipment under capital leases and leasehold improvements are
amortized using the straight-line method over the term of the respective lease,
or their estimated useful lives, whichever is shorter.  Expenditures for
maintenance and repairs are charged to expense as incurred.

Revenue recognition - Any revenues from research and development arrangements
are recognized pursuant to the terms of the related agreements, either as work
is performed, or as milestones are achieved.

Research and development - Research and development costs are expensed as
incurred.

Patent costs - Patent-related costs are expensed as incurred.

Lease expense - Expense related to the facility lease is recorded on a
straight-line basis over the lease term. The





                                      F-7

<PAGE>   46
difference between rent expense incurred and the amount paid is recorded as
deferred rent and is amortized over the lease term.

Stock Based Compensation - The Company accounts for stock-based employee
compensation under Accounting Principles Board (APB) Opinion No. 25,
"Accounting for Stock Issued to Employees", and related interpretations.
Effective January 1, 1996, the Company adopted the disclosure-only provisions
of Statement of Financial Accounting Standard No. 123, "Accounting for 
Stock-Based Compensation" ("SFAS 123").

Income Taxes - The Company accounts for income taxes using the liability method
as prescribed by Statement of Financial Accounting Standard No. 109, "Accounting
for Income Taxes" ("SFAS 109"). Deferred tax assets and liabilities are
determined based on differences between the financial reporting and tax bases of
assets and liabilities, and are measured using the enacted tax rates and laws
that will be in effect when the differences are expected to reverse.  The
measurement of deferred tax assets is reduced, if necessary, by a valuation
allowance for any tax benefits which are not expected to be realized.  The
effect on deferred tax assets and liabilities of a change in tax rates is
recognized in the period that such tax rate changes are enacted.

Loss per share - The Company calculates its loss per share under the provisions
of Statement of Financial Accounting Standard No.  128, "Earnings Per Share"
("SFAS 128").  SFAS 128 requires a dual presentation of "basic" and "diluted"
loss per share on the face of the income statement.  Basic loss per share is
computed by dividing loss by the weighted average number of shares of
common stock outstanding during each period.  Diluted loss per share includes
the effect, if any, from the potential exercise or conversion of securities,
such as stock options and warrants, which would result in the issuance of 
incremental shares of common stock. Only basic loss per share amounts have been
presented on the face of the statements of operations as the inclusion of
incremental shares would have been anti-dilutive.                 

Reclassification - Certain reclassifications have been made to prior years'
financial statements to conform to the current year presentation.

3. INVESTMENTS:

The Company invests in securities of the U.S. Treasury and U.S. Government
agencies.  Excess cash is invested on a short-term basis in U.S. government
based money market funds.  Unrealized gains at December 31, 1997 and 1996 total
$6,000 and $13,000, respectively.  The Company has not realized any losses on
its investments.

4.  FIXED ASSETS:

Fixed assets are stated at cost and are summarized as follows (in thousands):

<TABLE>
<CAPTION>
                                                                          December 31,    December 31,
                                                                             1997             1996
                                                                          ------------   --------------
 <S>                                                                         <C>           <C>
 Laboratory and office equipment                                              $3,147         $3,766
 Leasehold improvements                                                        2,625          2,433
                                                                             -------       --------

         Total                                                                 5,772          6,199

 Less accumulated depreciation and amortization                              (2,948)        (3,693)
                                                                             -------       --------
                                                                              $2,824         $2,506
                                                                             =======       ========
</TABLE>





                                      F-8

<PAGE>   47
5.  ACCOUNTS PAYABLE AND ACCRUED EXPENSES:

Accounts payable and accrued expenses consist of the following (in thousands):

<TABLE>
<CAPTION>
                                                                            December 31,     December 31,
                                                                                1997             1996
                                                                            ------------     ------------
 <S>                                                                           <C>              <C>
 Accounts payable                                                              $  215           $  176
 Clinical and regulatory costs                                                  1,197              720
 Manufacturing development costs                                                3,507            3,426
 Preclinical costs                                                                338              269
 Professional fees                                                                258              200
 Other                                                                            429              354
                                                                               ------           ------
                                                                               $5,944           $5,145
                                                                               ======           ======
</TABLE>


6.  EQUIPMENT LEASE OBLIGATIONS:

The Company leases equipment under various agreements with original terms of 48
months and accounts for these leases as capital leases. The net book value of
the equipment held under capital leases was approximately $38,000 and $149,000
at December 31, 1997 and 1996, respectively.


Future lease payments as of December 31, 1997 are as follows (in thousands):

<TABLE>
 <S>                                                                                               <C>
 Year Ending December 31, 1998                                                                     $36
 Less amount representing interest                                                                   2
                                                                                                ------
 Present value of future lease
                 payments at end of year                                                            34
                                                                                                ======
</TABLE>


                                      F-9

<PAGE>   48
7.  NOTE PAYABLE:

The Company has entered into a credit arrangement with a commercial bank under
which up to $1,500,000 may be borrowed to finance the acquisition of equipment
and the costs of improvements to the Company's leased facilities.  Borrowings
under this credit facility bear interest at rates ranging from 8.5% to the
prime rate minus one quarter percent.  The loans provide for monthly interest
payments, with principal payments due on contractual repayment dates.

As of December 31, 1997 and 1996, the Company had borrowed $1,500,000 and
$1,000,000, respectively, under this facility.

Any amounts outstanding under this credit arrangement shall become immediately
due and payable under certain circumstances, including the failure of the
Company to maintain certain minimum cash and investment balances, and financial
ratios.

The principal repayment obligations as of December 31, 1997 are as follows (in
thousands):
<TABLE>
<S>                       <C>
1998                      $         500
1999                              1,000
                                  -----

Total                     $       1,500
                                  =====
</TABLE>




                                      F-10

<PAGE>   49
8.  STOCKHOLDERS' EQUITY:

In August 1995, the Company consummated a public offering of 3,500,000 shares
of common stock with proceeds to the Company (after underwriting discounts and
offering expenses) of approximately $32,627,000.

In October 1995, pursuant to an arrangement with a contract manufacturer, the
Company issued to such manufacturer 125,000 shares of common stock with a fair
value of $10 per share. In connection therewith, the Company recorded a
non-cash charge to earnings of $1,250,000.

In May 1996, the Company increased the number of its authorized common shares
to 45,000,000.

In August 1996, the Company completed a private placement of 1,556,763 shares
of common stock, together with warrants as described below, with proceeds to
the Company (after offering expenses) of approximately $11,932,000.

In September 1996, pursuant to a buyout of a royalty arrangement, the Company
issued 550,000 shares of common stock. In connection, therewith, the Company
recorded a non-cash charge to earnings of $7,060,000.

In December 1997, the Company consummated a public offering of 2,587,500 shares
of common stock with proceeds to the Company (after underwriting discounts and
offering expenses) of approximately $19,172,000.

Warrants - Under a 1991 credit agreement with certain stockholders, the Company
granted warrants to the lenders to purchase an aggregate of 250,000 shares of
common stock at $8.00 per share. These warrants expire in 2001.  At December 31,
1997,  229,739 of these warrants are outstanding.

In October 1994, pursuant to an arrangement with a contract manufacturer, the
Company granted to such manufacturer a warrant to purchase 300,000 shares of
common stock at $7.50 per share. The warrant expires in 1999.

In connection with the August 1996 private placement, the Company issued common
stock together with warrants to purchase an aggregate of 1,011,896 shares of
common stock, exercisable at $8.48 per share.  The warrants contain provisions
to decrease the exercise price, and increase the issuable shares, under certain
circumstances.  Such circumstances include the issuance of shares of common
stock by the Company for a consideration per share less than the exercise price
of the warrants, and the issuance by the Company of securities convertible into
shares of common stock for which the exercise or conversion price is less than
the exercise price of the warrants. In this regard, as a result of the
Company's December 1997 public offering, the warrants were adjusted to be
exercisable for an aggregate of 1,017,872 shares of common stock and the
exercise price was decreased to $8.43 per share.   The warrant holders also
have a one-time right, in the event the average price of the Company's common
stock in any month prior to August 1999 falls below a certain level, to reduce
the exercise price of the warrant to 110% of such average price.

Stock option plans - In May 1991, the stockholders approved the 1990 Stock
Option Plan (the "1990 Plan") which provides for the granting of options for
the purchase of up to 160,000 shares of common stock.  In May 1996, the
stockholders approved the amended 1992 Stock Option Plan (the "1992 Plan")
which provides for the granting of options for the purchase of up to 2,500,000
shares of common stock.

The plans provide for the granting of incentive stock options and nonqualified
stock options and are administered by a committee of the Board of Directors.
The committee has the authority to determine the term during which an option
may be exercised (provided that no option may have a term of more than 10
years), the exercise price of an option and the rate at which options may be
exercised. Incentive stock options may be granted only to employees of the
Company. Nonqualified stock options may be granted to employees, directors or
consultants of the Company.  




                                      F-11

<PAGE>   50
For nonqualified stock options under the 1992 Plan and incentive stock options,
the exercise price can not be less than the fair market value of the underlying
common stock on the date of the grant.

In addition to the shares of common stock issuable upon exercise of options
granted under the Company's stock option plans, 734,383 shares of common stock
are issuable upon exercise of outstanding options granted to officers,
employees and consultants pursuant to other written agreements.  The exercise
price for these options was set by the Board of Directors, or a committee
designated by the Board, based upon an evaluation of the fair market value of
the Company's common stock on the date of grant. The options vest over various
periods, not exceeding five years, and expire no later than ten years from the
date of grant.

A summary of the status of the Company's stock options as of December 31, 1997,
1996 and 1995, and changes during the years ending on those dates, is presented
below (in thousands, except per share data):

<TABLE>
<CAPTION>
                                          1997                                 1996                                 1995
                                ----------------------------        ---------------------------         ---------------------------
                                 SHARES     WEIGHTED-AVERAGE        SHARES     WEIGHTED-AVERAGE         SHARES     WEIGHTED-AVERAGE
OPTIONS                                      EXERCISE PRICE                     EXERCISE PRICE                      EXERCISE PRICE
-------                         --------     --------------        --------     --------------         --------     --------------
<S>                                <C>                 <C>            <C>                 <C>             <C>                 <C>
Outstanding at beginning of        2,466               $6.07          2,048                $3.97          1,759               $3.07
year
Granted                              576               $7.51            782               $10.56            504               $7.16
Exercised                           (29)               $4.91          (196)               $ 2.56          (107)               $3.08
Forfeited                           (39)               $8.46          (168)               $ 5.01          (108)               $4.90
                                   -----                              -----                               -----
Outstanding at end of year         2,974               $6.33          2,466               $ 6.07          2,048               $3.97

Exercisable at end of year         1,586               $4.29          1,203               $ 3.00          1,157               $2.39
</TABLE>

The following table summarizes information about stock options outstanding as
of December 31, 1997 (in thousands, except per share data):


<TABLE>
<CAPTION>
                                     OPTIONS                                           OPTIONS
                                   OUTSTANDING                                       EXERCISABLE
                  ---------------------------------------------------      -------------------------------
                     SHARES      WEIGHTED AVERAGE                             SHARES
RANGE OF          OUTSTANDING       REMAINING        WEIGHTED AVERAGE      EXERCISABLE     WEIGHTED AVERAGE
EXERCISE PRICES   AT 12/31/97    CONTRACTUAL LIFE     EXERCISE PRICE        AT 12/31/97     EXERCISE PRICE
----------------  -----------    ----------------     --------------       ------------     --------------
<S>                      <C>         <C>                  <C>                    <C>               <C>
$.002 - $.40               146        1 Year               $  0.02                 146             $  0.02
$2.00 - $3.75            1,039       5 Years               $  2.73                 957             $  2.65
$5.25 - $8.00              838       8 Years               $  7.22                 196             $  6.49
$8.25 - $11.63             936       8 Years               $ 10.34                 276             $ 10.19
$16.75                      15       6 Years               $ 16.75                  11             $ 16.75
                 -------------                                             -----------
$.002 - $16.75           2,974       7 Years               $  6.33               1,586             $  4.29
</TABLE>





                                      F-12

<PAGE>   51
The Company applies APB Opinion No. 25 and related Interpretations in accounting
for options.  Accordingly, no compensation cost has been recognized for
employee stock option grants.  Had compensation cost for employee stock option
grants been determined based on the fair value at the grant dates for awards
consistent with the method of SFAS No. 123, the Company's loss and loss per
share would have been increased to the pro forma amounts indicated below (in
thousands, except per share data):

<TABLE>
<CAPTION>
                                                      1997                 1996                 1995
                                                      ----                 ----                 ----
 <S>                 <C>                         <C>                  <C>                <C>
 Loss                As reported                 $(14,381)            $(30,620)            $(17,215)
                     Pro forma                   $(16,649)            $(31,816)            $(17,410)

 Loss per share -    As reported                   $(0.73)              $(1.71)              $(1.17)
 basic               Pro forma                     $(0.85)              $(1.78)              $(1.18)
</TABLE>




The resulting effect on pro forma loss and pro forma loss per share disclosed
above is not likely to be representative of the effects on a pro forma basis in
future years, because 1997, 1996 and 1995 pro forma results include the impact
of only three, two and one years, respectively, of grants and related vesting,
while subsequent years will include additional years of grants and vesting.
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>
                                               1997                      1996                     1995
                                               ----                      ----                     ----
<S>                                     <C>                       <C>                      <C>
Range of risk free interest rates       5.8% - 6.6%               6.1% - 6.8%              5.6% - 7.2%

Dividend yield                                   0%                        0%                       0%

Volatility factor                               75%                       79%                      82%

Expected life of options (in years)               6                         6                        6
</TABLE>

The Weighted Average Fair Value of options granted was $5.31 in 1997, $7.54 in 
1996 and $5.30 in 1995.





                                      F-13

<PAGE>   52
9.  INCOME TAXES:

The Company has approximately $95,707,000 of net operating loss ("NOL")
carryforwards for income tax purposes and approximately $5,675,000 of research
and development tax credits available to offset future federal income tax
subject to limitations for alternative minimum tax. The NOL and research and
development credit carryforwards are subject to examination by the tax
authorities and expire in various years from 2003 through 2012.  The NOL
carryforward differs from the accumulated deficit principally due to differences
in the recognition of certain research and development expenses for financial
and federal income tax reporting.

The Tax Reform Act of 1986 contains provisions that may limit the NOL and
research and development credit carryforwards 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 that company's
ability to utilize its NOL carryforwards from tax periods prior to the ownership
change. The Company is subject to an annual limitation on the use of its NOL
carryforwards pursuant to these provisions. The Company does not believe that
such limitation will have a material adverse impact on the utilization of its
carryforwards.

The Company's NOL, research and development tax credit carryforwards and
temporary differences represent a previously unrecognized tax benefit.
Recognition of these benefits requires future income. Because the attainment of
future income is uncertain, the Company has established a valuation allowance,
which increased by approximately $6,954,000 during 1997, for the entire amount
of the tax benefit.

Significant components of the Company's deferred tax assets as of December 31,
1997 and 1996 are as follows (in thousands):


<TABLE>
<CAPTION>
                                                            1997                  1996
                                                            ----                  ----

 <S>                                                   <C>                   <C>
 Net operating loss carryforwards                      $  33,497             $  29,077

 Research credits                                          5,675                 4,258

 Capitalized research and development                      2,284                 2,360

 Other, net                                                2,046                   853
                                                       ---------             ---------
 Net deferred tax assets                                  43,502                36,548

 Valuation allowance for deferred tax assets           $(43,502)             $(36,548)
                                                       ---------             ---------
 Total deferred tax assets                             $     --              $     --
                                                       =========             =========
</TABLE>


10.  COLLABORATIVE AGREEMENTS:

In 1990, the Company entered into a Research and License Agreement with
Colgate-Palmolive Company ("Colgate") pursuant to which the Company received
research funding of approximately $280,000 in the year ended December 31, 1995.
This agreement has expired.

In August 1994, the Company entered into a collaboration in the nutritional
field with Abbott Laboratories ("Abbott").  The Company recorded revenue of
$88,000, $150,000, and $150,000 in the years ended December 31, 1997, 1996 and
1995, respectively, under this arrangement.

The Company recorded revenues of $1.9 million in 1995 relating to the execution
of an agreement in principle with Fisons plc ("Fisons") in September 1995, and
the termination by Fisons of this arrangement in November 1995.

In February 1997, the Company entered into a development, supply and
distribution agreement (the "Agreement") in North America with SmithKline
Beecham ("SB") for Cytolex(TM).  SB has paid the Company $10.0 million under 
this Agreement, and may make additional payments to Magainin of up to $22.5 
million,





                                      F-14

<PAGE>   53
upon the occurrence of certain product milestones.  SB will also fund a
percentage of any development expenses for any additional indications for
Cytolex(TM).  Upon the commencement of commercial sales by SB, Magainin will be
responsible for the supply of Cytolex(TM) and SB will be responsible for the
marketing and sale of Cytolex(TM).  Magainin will receive certain percentages of
SB sales revenues under agreed upon terms.  The Agreement also gives SB the
right to negotiate for rights to another Magainin product development candidate,
under certain terms and conditions.  The Agreement gives SB the right to
terminate on a country by country basis if SB determines it is not economical to
distribute Cytolex in those areas.

The Company has rights under license agreements to certain patents and patent
applications under which the Company expects to owe royalties on sales of any
products which are covered by issued patent claims. Additionally, certain of
these agreements also provide that if the Company elects not to pursue the
commercial development of any licensed technology, or does not adhere to an
acceptable schedule of commercialization, then the Company's exclusive rights
to such technology would terminate.

11.  401(K) PLAN:

The Company maintains a 401(k) retirement plan available to all full-time,
eligible employees. Employee contributions are voluntary and are determined on
an individual basis, limited to the maximum amount allowable under federal tax
regulations.  The Company, at its discretion, may make certain contributions to
the plan. No such contributions have been made through December 31, 1997.

12.  COMMITMENTS, CONTINGENCIES AND OTHER MATTERS:

Manufacturing

The Company is working with Abbott with regard to the development by Abbott of
a solution phase chemical process to manufacture bulk drug substance for
Cytolex on a commercial scale.  The Company is currently dependent upon Abbott
for the production of bulk drug substance for Cytolex.  In the event that bulk
drug substance for Cytolex is not manufactured at Abbott, the Company will need
to secure other manufacturing arrangements.  The process developed by Abbott is
proprietary, and in the event the Company desires to utilize, or have another
party utilize, such proprietary technology, the Company would be required to
make license payments to Abbott.  Further progress in scale-up and
manufacturing development efforts will be required to enable the Company to
manufacture and sell Cytolex on a profitable basis.  This may require
substantial additional funds.  The Company has certain efforts under way with
respect to alternative manufacturing sources, including recombinant
manufacturing; however, these programs are at an early stage, and significant
expenditures over an extended period of time will be required to develop a
commercially viable process.  No assurance can be given that a cost-effective
manufacturing process can ultimately be developed, or that any such process
would be approved by the FDA, or that the Company, Abbott or others will be
able to manufacture Cytolex on a commercially viable basis.

The Company's arrangement with Abbott also provides for the issuance by the
Company to Abbott of up to 500,000 shares of its Common Stock and the
obligation to pay a royalty on any future sales of Cytolex.  Stock issuances by
the Company to Abbott will result in a charge to earnings, representing the
fair value of the shares when issued.  The Company issued 125,000 shares of
common stock to Abbott in October 1995, resulting in a charge to earnings of
$1,250,000 in 1995.  Future stock issuances are related to the achievement by
Abbott of contractual performance milestones.

The Company expects to finalize an agreement with Abbott for the purchase of 
bulk drug substance for Cytolex in 1998, prior to any FDA approval of Cytolex,
resulting in significant research and development expenses in 1998.

The Company also expects to conduct significant manufacturing development
activities for its other products under development.  The Company is currently
working with outside contractors for the chemical production of squalamine.
The Company expects to expend significant resources in the production of
squalamine and any other compounds under development, and there can be no
assurance that these efforts will be successful.





                                      F-15

<PAGE>   54
Rent

The Company has entered into two operating leases for its laboratory and
corporate office facilities.  These leases provide for minimum annual rent
payments through 2001 as follows (in thousands):

<TABLE>
<S>                                                                  <C>
Year Ending December 31,
1998                                                                 $436
1999                                                                  435
2000                                                                  119
2001                                                                   10
</TABLE>

The leases provide for escalations relating to increases in real estate taxes
and certain operating expenses.

Rent expense was approximately $295,000, $310,000 and $297,000, for the years
ended December 31, 1997, 1996 and 1995, respectively.





                                      F-16

<PAGE>   55
                                 Exhibit Index

The Exhibits that have been filed herewith this Form 10-K are summarized as
follows:


<TABLE>
<CAPTION>
 EXHIBIT NO.                                    DESCRIPTION                                 

   <S>           <C>

   10.13         Lease with respect to Plymouth Meeting, PA office space

   23            Consent of Richard A. Eisner & Company, LLP

   24            Power of Attorney (included on signature page of this Annual Report on
                 Form 10-K)

   27            Financial Statement Data Schedule
</TABLE>