<PAGE>   1
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-K

              ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                        SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997          COMMISSION FILE NO. 0-19659

                       CHRYSALIS INTERNATIONAL CORPORATION
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

                DELAWARE                                         22-2877973
    (STATE OR OTHER JURISDICTION OF                           (I.R.S. EMPLOYER
     INCORPORATION OR ORGANIZATION)                          IDENTIFICATION NO.)

   575 ROUTE 28, RARITAN, NEW JERSEY                               08869
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)                         (ZIP CODE)

       REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (908) 722-7900

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

                                      NONE

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

            COMMON STOCK, PAR VALUE $0.01 PER SHARE ("COMMON STOCK")

         INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS
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
REQUIREMENT FOR THE PAST 90 DAYS. YES |X| NO |_|

         INDICATE BY CHECK MARK IF DISCLOSURE OF DELINQUENT FILERS PURSUANT TO
ITEM 405 OF REGULATION S-K IS NOT CONTAINED HEREIN, AND WILL NOT BE CONTAINED,
TO THE BEST OF REGISTRANT'S KNOWLEDGE, IN DEFINITIVE PROXY OR INFORMATION
STATEMENTS INCORPORATED BY REFERENCE IN PART III OF THIS FORM 10-K OR ANY
AMENDMENT TO THIS FORM 10-K. |_|

         THE AGGREGATE MARKET VALUE OF COMMON STOCK HELD BY NON-AFFILIATES AS OF
MARCH 20, 1998 AT A CLOSING PRICE OF $2.75 PER SHARE AS REPORTED BY THE NASDAQ
NATIONAL MARKET WAS APPROXIMATELY $24,295,552.

         THE NUMBER OF SHARES OF COMMON STOCK OUTSTANDING AS OF MARCH 20, 1998
WAS 11,430,764.

                       DOCUMENTS INCORPORATED BY REFERENCE

(a)      THE COMPANY'S PROXY STATEMENT FOR ITS 1998 ANNUAL MEETING OF
         STOCKHOLDERS IS INCORPORATED HEREIN BY REFERENCE IN PART III OF THIS
         ANNUAL REPORT ON FORM 10-K.
<PAGE>   2
                                     PART I

ITEM 1.  BUSINESS

                                     GENERAL

         Chrysalis International Corporation, a Delaware corporation (the
"Company" or "Chrysalis"), incorporated in 1988, is an international contract
research organization ("CRO") providing a broad range of integrated drug
development services primarily to the pharmaceutical and biotechnology
industries. This broad portfolio of drug development services includes
transgenic discovery research, preclinical development and clinical capabilities
that enable the Company to manage a comprehensive drug development program or a
client's specific requirements. The Company utilizes its international expertise
and experience in preclinical and clinical services to provide a coordinated
approach for a client to transition its drug through various preclinical to
clinical stages of development thereby minimizing certain delays which typically
occur before a new drug is introduced to the market. In addition, the Company is
the only CRO that is currently able to use its proprietary transgenic and
licensed gene targeting technology to provide services for its clients that
require transgenic animal models in order to determine the function of human
genes and identify therapeutic targets implicated in disease and for the
evaluation of therapeutic lead compounds for further development. The Company
generates substantially all of its revenues from its drug development services
and provides services for more than 250 clients in 26 countries.

         On March 16, 1998, the Company issued a $5.0 million subordinated
debenture to a wholly-owned subsidiary of MDS Inc., a Canadian corporation
("MDS"). As part of this transaction, the Company also issued a warrant to
purchase 2,000,000 shares of Common Stock for $2.50 per share. In addition, the
Company and MDS entered into a standstill agreement which, among other things,
governs the ownership and acquisition of securities of the Company by MDS and
its affiliates. As a part of this transaction, MDS and the Company will explore
opportunities to pursue strategic alliances and other business opportunities
with respect to their respective operations.

         On December 18, 1996, the Company issued 2,632,600 shares of Common
Stock in connection with the acquisition (the "Acquisition") by the Company of
all of the outstanding capital stock of, or equity interests in, BioClin, Inc.,
a Delaware corporation, BioClin Europe AG, a Swiss corporation, BioClin GmbH, a
German corporation, Kilmer N.V., a Netherlands Antilles corporation, and BioClin
Institute of Clinical Pharmacology GmbH, a German corporation (collectively, the
"BioClin Group"). The Acquisition was recorded using the "pooling-of-interests"
method of accounting.

         Chrysalis is also the exclusive commercial licensee of a U.S. patent
covering DNA microinjection ("DNA Microinjection"), the process widely used in
the pharmaceutical and biotechnology industries to develop transgenic animal
models. The Company employs this process for its transgenic research and drug
discovery services and grants several types of sublicenses for the use of this
technology by commercial firms and academia. These sublicenses entitle the
Company to receive revenues consisting of fees and, in certain cases, royalties.


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NEW DRUG DEVELOPMENT PROCESS OVERVIEW

         Drug development is an expensive and lengthy process. Before a new drug
can be marketed, it must undergo extensive testing and regulatory review to
determine its safety and efficacy. This process consists of many stages -- two
of the most critical being preclinical and clinical testing. In preclinical
testing, the sponsor of the new drug conducts laboratory analyses and animal
tests to determine the basic biological activity and safety of the drug. After
successfully completing the preclinical phase, the drug undergoes a series of
clinical tests in humans, typically progressing from dosing studies in healthy
volunteers to testing in patients with the targeted disease. The information
generated during these trials is critical for gaining marketing approval from
the United States Food and Drug Administration (the "FDA") or other regulatory
agencies. In the United States, preclinical and clinical testing must comply
with the requirements of Good Laboratory Practices ("GLP") and Good Clinical
Practices ("GCP") and other standards promulgated by the FDA and other federal
and state governmental authorities.

         The FDA pioneered the use of clinical trials for new drug development,
and the agency's approval process has shaped much of drug regulation worldwide.
In recent years, the FDA and corresponding regulatory agencies of the major
industrial countries, including Canada, Japan and the European Union (the "EU"),
commenced discussions to develop common standards for both the conduct of
preclinical and clinical studies and the format and content of applications for
new drug approvals. Data from multi-national studies adhering to GCP are now
generally acceptable to the FDA and the governments within the EU.

         In the United States, a drug sponsor must file an Investigational New
Drug Application (the "IND") with the FDA before the commencement of human
testing of a drug. The IND includes preclinical testing results and sets forth
the sponsor's plans for conducting human clinical trials. The design of these
plans, known as the study protocol, is critical to the success of the drug
development effort because the protocol must correctly anticipate the data and
results that the FDA will require before approving the drug.

         Extensive preclinical testing, involving pharmacology and toxicology
studies, is required before a drug developer may obtain permission to conduct
safety and efficacy testing in humans. In efficacy studies, drug candidates are
evaluated by administering them to animal models that simulate human disease
conditions. Such screens are used primarily by pharmaceutical and biotechnology
companies. In toxicology studies, drug candidates are tested in normal, healthy
animals to determine their potential toxicity to humans. In addition, new
industrial and agricultural chemicals often require extensive toxicology testing
before they may be sold. Consequently, toxicology tests are used not only by
developers of new drugs, but also by developers of other chemical products.

         Human trials usually start on a small scale to assess safety and then
expand to test efficacy. Trials are usually grouped into four phases, with
multiple trials generally conducted within each phase. Clinical trials often
represent the most expensive and time-consuming part of the overall drug
development process. The information generated during these trials is critical
for gaining marketing approval from the FDA or other regulatory agencies.


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         Phase I. Phase I trials are conducted on healthy volunteers, typically
20 to 80 persons, to develop basic safety data relating to toxicity, metabolism,
absorption, elimination and other pharmacological actions.

         Phase II. Phase II trials are conducted on a small number of subjects,
typically 100 to 200 patients, who suffer from the drug's targeted disease or
condition. Phase II trials offer the first evidence of clinical efficacy, as
well as additional safety data.

         Phase III. Phase III trials are conducted on a significantly larger
population of several hundred to several thousand patients who suffer from the
targeted disease or condition. Phase III trials are designed to measure efficacy
on a large scale as well as long-term side effects.

         Phase IV. As a condition of granting marketing approval, the FDA may
require that a sponsor continue to conduct additional clinical trials, known as
Phase IV trials, to monitor long-term risks and benefits, study different dosage
levels, or evaluate different safety and efficacy parameters in target patient
populations. With the increasing importance of Phase IV trials also comes
increased complexity in the scope of the trials (i.e., the number of patients
tested) and the manner in which they are conducted (i.e., the number of sites at
which testing is performed).

         After the successful completion of Phase III trials, the sponsor of a
new drug may submit a New Drug Application ("NDA") to the FDA. The NDA is a
comprehensive filing that includes, among other things, the results of all
preclinical and clinical studies, information about the drug's composition and
the sponsor's plans for producing, packaging and labeling the drug. Most of the
clinical data contained in an NDA is generated during the Phase II and III
trials. Drugs that successfully complete FDA review may be marketed in the
United States, subject to the conditions imposed by the FDA in its approval.

INDUSTRY OVERVIEW

         The CRO industry provides independent product development services
primarily for the pharmaceutical and biotechnology industries. Companies in
these industries outsource product development services to CROs in order to
manage the drug development process more efficiently and cost-effectively to
maximize the benefits in time and profit of patent-protected products. CROs
derive substantially all of their revenue from the research and development
expenditures of pharmaceutical and biotechnology companies. The CRO industry has
evolved from providing primarily preclinical services in the 1970s to a full
service industry offering virtually all preclinical and clinical services
required for development of new drugs. In addition to managing preclinical and
clinical studies, CROs may also provide scientific results analysis and
reporting according to good clinical and laboratory practices as required by
applicable regulatory authorities.

         The CRO industry is highly fragmented, including several hundred small,
limited-service providers and a few large, full service CROs with global
capabilities. Although there are few barriers to entry for small,
limited-service providers, the Company believes there are significant barriers
to becoming a full service CRO with global capabilities. Some of these barriers
include the infrastructure necessary to serve the global needs of clients, the
high fixed personnel costs required to develop broad therapeutic capabilities,
the expertise and facilities


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necessary to provide both general and specialty preclinical and clinical
services, the ability to access investigators and specific patient populations
in sufficient numbers, and the need for sophisticated management information
systems, expertise and technology to manage complex clinical trials.

         As a result of competitive pressures and economies of scale, the CRO
industry is consolidating. Mergers and acquisitions have resulted in the
emergence of a few full service CROs with the international human, technical and
financial resources to conduct the full range of preclinical and clinical drug
development trials on behalf of pharmaceutical and biotechnology companies. The
Company believes that industry trends favor those CROs able to provide a full
range of services in the top drug development markets around the world.

TRENDS AFFECTING THE CRO INDUSTRY

         The Company believes that certain industry trends will continue to
increase the need for pharmaceutical and biotechnology companies to outsource
their drug development requirements. These trends include:

         (i)      Cost Containment Pressures. The desire of many pharmaceutical
companies to respond to cost containment pressures and reduce the high fixed
costs associated with drug development by relying on the combination of internal
resources and CROs.

         (ii)     Market Globalization. The attempt by pharmaceutical and
biotechnology companies to outsource drug development to CROs with global
capabilities to maximize worldwide sales and profits from a given drug by
pursuing regulatory approvals in multiple countries simultaneously.

         (iii)    Maturation of the Biotechnology Industry. The maturation of
the biotechnology industry and the resulting increase in the demand for
expertise and services provided by outside sources, including CROs.

         (iv)     Need for Faster Drug Development. The desire by pharmaceutical
and biotechnology companies to reduce the time required to develop and bring a
new drug to market by outsourcing preclinical studies and clinical trials to
CROs that provide a full range of services.

         (v)      Increasingly Stringent Regulation. Increasingly complex and
stringent regulatory requirements on a global basis, together with recent
efforts to develop globally harmonized regulatory standards, escalate the
demands on data collection, analysis, and reporting which prompts outsourcing to
CROs with global data management expertise and capability.

         (vi)     Therapeutic Focus on Chronic Diseases. The escalation of
worldwide research and development expenditures for new drugs, including amounts
spent on services of the type provided by CROs, stemming from pressures to
develop new drugs for the treatment of chronic disorders and life-threatening
diseases.


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         (vii)    Need to Focus Internal Resources. The efforts by
pharmaceutical companies to reserve their internal resources for the development
of new drugs by using CROs to manage and conduct preclinical studies and
clinical trials.

         (viii)   Growing Interest in Genomics. The growth by pharmaceutical and
biotechnology companies in the area of genomics research in order to determine
the function of human genes and identify gene targets implicated in disease.

         In response to these trends, the CRO industry has begun to experience
consolidation, including the formation of strategic alliances. Pharmaceutical
companies have begun to utilize a smaller pool of CROs and have sought to
transform their contractual relationships with CROs from "vendor" to "strategic
partner." Biotechnology companies have also begun to take a more global,
long-term perspective on their CRO contracting activities.

BUSINESS STRATEGY

         The Company follows a strategy to focus on these industry trends. The
primary components of this strategy include: (i) the utilization of a broad
range of services enabling clients to use the preclinical and/or clinical drug
development services provided by the Company on an international basis; (ii) a
coordinated approach for a client to transition its drug through various
preclinical to clinical stages of development thereby minimizing certain delays
which typically occur before a new drug is introduced to the market; (iii) the
use of transgenic and preclinical services to establish early relationships with
clients and the leveraging of its existing transgenic and preclinical client
base to utilize the Company's broad range of drug development services, in
particular, drug development services relating to Phase I through Phase IV
trials; (iv) the utilization of transgenic animal technology to provide services
to biotechnology and pharmaceutical companies of the genomics industry; (v) the
expansion, through selective strategic alliances and/or acquisitions or through
internal growth, into new geographic areas and new areas of therapeutic
specialization and into complementary businesses; (vi) the continued investment
of resources in the Company's specialty preclinical services such as continuous
infusion techniques and transgenic technology for functional genomics research;
and (vii) the continuation of investment in and utilization of information and
data management technology.

                                    SERVICES

         The Company provides a broad portfolio of drug development services.
The major categories of services offered by the Company are as follows:

TRANSGENIC SERVICES.

         The Company has observed an acceptance by the pharmaceutical and
biotechnology industries in the use of transgenic laboratory animal model
technology as a tool to improve drug discovery programs. This acceptance,
together with the Company's scientific experience, its proprietary DNA
Microinjection technology and its gene targeting commercial research license,
provides the Company with the opportunity to offer its portfolio of specialty
transgenic-based contract research services for those companies electing to
outsource all or a portion of their transgenic animal model needs. These
transgenic-based specialty contract


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research services include gene function assessment, custom model development
programs, molecular biology services and other related services.

         In the area of genomics research, the Company's transgenic animal
technology is being used to determine the functions of human genes and to
identify human gene targets implicated in disease. Transgenic animal technology
provides for the genetic manipulation of animals, allowing for the production of
animals that more accurately reflect human biochemistry, physiology and
pathology. Coupled with the identification of new genes, resulting from
worldwide efforts to map and sequence the human genome, transgenic animal
technology allows for the generation of new laboratory animals with specifically
engineered genetic traits. These new animals will facilitate the understanding
of the molecular basis of disease progression which may lead to the
identification of new pharmacological approaches and improved animal models for
evaluating new pharmaceutical therapies. By identifying more specific
pharmaceutical targets and providing more informative preclinical data on
experimental compounds, these genetically modified animals may have the
potential to reduce the time to bring new pharmaceutical therapies to market.

PRECLINICAL SERVICES.

         The Company believes it offers clients, on an international basis, a
broad range of preclinical drug development services and can provide a majority
of the preclinical testing requirements necessary to secure FDA (U.S.), EC
(Europe) and MHW (Japan) approval to initiate human clinical trials. The Company
provides the following preclinical drug development services:

         Toxicology. Toxicology studies are designed to identify and evaluate
any harmful effects that pharmaceuticals or chemicals might cause to humans.
These studies are required in connection with the FDA approval process. The
Company provides the following toxicology testing services: mutagenesis/genetic
toxicology; teratology; reproduction/fertility; immunotoxicology; continuous
infusion; carcinogenesis; and acute, sub-acute and chronic evaluations. The
Company believes it has a recognized specialty expertise in continuous infusion
administration techniques and immunotoxicology.

         Pharmacology. Pharmacology studies are designed to quantify the
properties and reactions of drugs primarily in relation to their therapeutic
value. The Company provides testing in the following therapeutic areas: central
nervous system; cardiovascular; pulmonary; anti-inflammatory; gastrointestinal;
cardiopulmonary; and analgesia. In addition, the Company provides safety
pharmacology studies, which include the evaluation of possible effects on the
central nervous system, cardiovascular, gastrointestinal, pulmonary and renal
function as well as adverse interaction with drugs likely to be co-administered
with the development candidate.

         Pharmacokinetics. Pharmacokinetic studies are designed to characterize
the time course of drug absorption, distribution, metabolism and excretion and
relate these processes to the intensity and time course of pharmacological and
toxicological effects of drugs.

         Immunology. Immunology studies are designed to evaluate and test the
immunoregulatory potential of substances.


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CLINICAL SERVICES.

         The Company's clinical services include clinical trial management
services, clinical data management and biostatistical services, and product
registration and regulatory services. These services can be provided separately
or as an integrated package. Services from each of these categories can be
utilized for the development and execution of an NDA.

         Clinical Trial Management Services. The Company offers complete
services for the design, placement, performance and management of clinical trial
programs, critical elements in obtaining regulatory approval for drugs. The
Company has performed services in connection with trials in many therapeutic
areas. The Company's multi-disciplinary clinical trials group has the ability to
examine a product's existing preclinical and clinical data for the purposes of
designing protocols for clinical trials in order to ascertain evidence of the
product's safety and efficacy.

         The Company's services include management of Phase I through IV trials,
including design of operations manuals, identification and recruitment of trial
investigators, initiation of sites, monitoring for strict adherence to GCP, site
visits to ensure compliance with protocol procedures and proper collection of
data, interpretation of trial results and report preparation. Many of the
Company's current projects involve Phase II, III or IV clinical trials, which,
in most cases, are significantly larger and more complex than Phase I trials.

         Phase I Services. The Company provides a number of specialized Phase I
services. They include: computerized volunteer databases; a clinical
pharmacology unit; access to special populations; vital signs; telemetry; and
statistical evaluation. Phase I trials are conducted on healthy volunteers,
typically 20 to 80 persons, to develop basic safety data relating to toxicity,
metabolism, absorption, elimination and other pharmacological actions.

         Tolerability pharmacokinetic and pharmacodynamic investigations and
drug-drug interaction studies can be performed in young and elderly healthy
volunteers, as well as in special populations, including patients with renal or
hepatic impairment. The Company has access to a large population of suitable and
reliable volunteers, and, since its opening, has built up an active panel of
approximately 2,000 volunteers which is continually reviewed and expanded.

         The Company's Phase I capability complements its European and North
American clinical operations for Phase II to IV trials. This network of clinical
facilities allows parallel, worldwide development of pharmaceutical products.

         Phase II -- Phase IV Services. The Company provides Phase II through
Phase IV services, including efficacy testing, additional safety data, long-term
risks and side effects and other matters. The Company maintains a network of
physicians who serve as investigators, hospitals and university centers for in-
and outpatient studies, established research sites performing special
investigations and a selection of centralized laboratories in each country
across Europe, Israel, and North America. In connection with Phase II through
Phase IV services, the Company provides project management, traditional
monitoring or monitoring by fax or remote/direct data entry and data management.


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         One recent development in the CRO industry is the emergence of trials
involving tests on over 1,000 patients over a period of several years at
multiple sites. These large multiple site trials have resulted from the drug
companies' emphasis on treating and curing chronic disorders and the resulting
need to thoroughly test large numbers of patients for long-term side effects of
new drugs. The Company is able to conduct large multiple site trials and
actively markets its capabilities in this area.

         Monitoring for Strict Adherence to GCP. Efficient data collection, form
design, detailed operations manuals and site visits by the Company's clinical
research associates ("CRAs") are utilized to determine whether clinical
investigators and their staff follow established protocols and accurately record
the findings of the trials. In addition, the Company has quality assurance
auditors that provide additional internal and external auditing.

         In connection with its services, the Company assists clients with one
or more of the following:

         (i)      Study Protocol. The protocol defines the medical issues the
study seeks to examine and the statistical tests to be conducted such as the
frequency and type of laboratory and clinical measures that are to be tracked
and analyzed, the number of patients required to produce a statistically valid
result, the period of time over which they must be tracked and the frequency and
dosage of drug administration.

         (ii)     Case Report Forms. Once the study protocol has been finalized,
special forms for recording the required information must be developed. These
forms are called Case Report Forms ("CRFs").

         (iii)    Site and Investigator Recruitment. The drug is administered to
patients under the supervision of physicians who serve as investigators, at
hospitals, clinics or other locations, referred to as sites. Potential
investigators may be identified by the drug sponsor or the Company, which then
solicits the investigators' participation in the study. Generally, the
investigators contract directly with the Company. The trial's success depends on
the successful identification and recruitment of investigators with proper
expertise and an adequate base of patients who satisfy the requirements of the
study protocol. The Company maintains a network of investigators who have
conducted clinical trials.

         (iv)     Patient Recruitment and Enrollment. The Company recruits Phase
I volunteers and maintains a database of such volunteers. The investigators,
however, find and enroll patients suitable for the Phase II through IV trials
according to the study protocol. Prospective patients are required to review
information about the drug and its possible side effects and sign an informed
consent to record their knowledge and acceptance of potential side effects.
Patients also undergo a medical examination to determine whether they meet the
requirements of the study protocol. Patients then receive the drug and are
examined by the investigator as specified by the study protocol.

         (v)      Study Monitoring and Data Collection. As patients are examined
and tests are conducted in accordance with the study protocol, data are recorded
on CRFs and laboratory reports. The data are collected from study sites by CRAs.
CRAs visit sites regularly to ensure


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that the CRFs are completed correctly and that all data specified in the
protocol are collected. CRFs are reviewed for consistency and accuracy before
their data are entered into an electronic database.

         (vi)     Medical Affairs. Throughout the course of a clinical trial,
the Company may provide various medical research and services, including medical
monitoring of clinical trials, interpretation of clinical trial results and
preparation of clinical study reports.

         (vii)    Report Writing. The results of statistical analysis of data
collected during the trial, together with other clinical data, are included in a
final report generated for inclusion in a regulatory document.

         (viii)   Information Technology. A fully networked information system
is available to facilitate complete computerized data management of Phase I
through Phase IV trials. Data capture for Phase I is maintained by direct CRF
"bedside" entry of primary data and the creation of the electronic CRF. Data
collected in CRFs is entered into the study database within 72 hours of
collection. Laboratory data is on-line for review by physicians and project
managers.

         For Phase II through Phase IV trials, monitored CRF pages are forwarded
to the Company's two data management centers (Dusseldorf, Germany and Austin,
Texas) for double data entry. Query lists are generated and returned to the
monitors for resolution. Alternatively, the Company offers the Almedica Fax
Monitoring(TM) system whereby completed CRF pages are transmitted from the sites
directly to either of the Company's two data management centers.

         Clinical Data Management and Biostatistical Services. The Company has
experience in the creation of scientific databases for all phases of the drug
development process. These databases provide clients with data abstraction, data
review and coding, data verification and editing and problem data resolution
capabilities. The Company utilizes an imaging technology process which
eliminates time and minimizes potential data entry errors by electronically
routing, tracking and querying optically scanned CRFs. The Company's data
management professionals assist in the design and development of study protocols
and CRFs, training manuals and training sessions for investigators and
coordinators.

         The Company's biostatistics professionals provide biostatistical
consulting, database design, data analysis and statistical reporting. The
Company's biostatisticians provide clients with assistance in all phases of drug
development. These professionals develop and review protocols, design
appropriate analysis plans and design report formats to address the objectives
of the study protocol, as well as the client's individual objectives.

         The Company believes that its data management and biostatistical
services capabilities can be utilized by a client more effectively when packaged
as part of its total clinical trials management services in the conduct of Phase
I through Phase IV trials. This packaging permits a faster and less costly
clinical trial process, as the data are collected and analyzed more rapidly and
the decision to move to the next phase can be made more quickly. Although the
Company believes that many pharmaceutical companies treat each phase as a
distinct trial, the Company emphasizes this packaged approach as an integrated
process.


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         Product Registration Services/Regulatory Affairs. The pharmaceutical
companies, who are clients of the Company, have their own regulatory expertise
and generally register their products without the assistance of third parties.
In connection with its Phase I through Phase IV services to these pharmaceutical
companies, the Company provides regulatory strategy formulation, consultation
and, if requested, acts as a liaison with the FDA and other international
regulatory agencies.

         The Company intends to market its clinical testing services to
biotechnology companies which may not have experience or expertise in regulatory
and product registration matters. As part of its clinical trial services, the
Company offers these clients comprehensive product registration services,
document preparation, regulatory strategy formulation and compliance, and may
act as liaison with the FDA and other international regulatory agencies.

         Although to date the revenues from these services to biotechnology
companies have not been material, the Company believes it necessary to offer
these services to be competitive in the CRO industry. As a result, the Company's
regulatory affairs professionals review existing published literature, assess
the scientific background of a product, assess the competitive and regulatory
environment, identify deficiencies and define the steps necessary to obtain
registration in the most expeditious manner. Through this service, the Company
may assist its clients to determine the feasibility of developing a particular
product or product line.

         The Company's regulatory affairs professionals have experience in the
analysis, preparation and submission of FDA regulatory documents covering a wide
range of products, including prescription and over-the-counter drugs. The
Company also has experience with preparing regulatory documentation for
submission to European regulatory authorities.

                                    MARKETING

         The majority of new studies conducted by the Company are derived from
existing clients. To obtain new clients, the Company contacts potential clients
directly through its marketing and sales representatives and its senior business
management, participates in various scientific association and/or business
symposia, and indirectly via such media as scientific and trade journal
advertising, brochures, and direct mailings. Further, the Company's sales and
marketing representatives target the promotion efforts to potentially new
clients who are not familiar with the Company's services, as well as to the
expansion of services for existing clients. In addition, the Company's
scientific personnel participate in a variety of business/scientifically
oriented endeavors such as publishing scientific papers and making presentations
at scientific meetings. The Company also participates in, and advertises at,
commercial conferences. Further, the Company also attends and provides exhibits
at selected industry trade shows in the United States and Europe.

         The Company currently coordinates its marketing efforts for its broad
range of services through a central business development function, which
includes the involvement of senior operational and scientific personnel in this
effort. The Company's marketing personnel seek new clients, seek contracts with
new therapeutic areas or divisions with existing clients, cross-sell other
services to existing clients and develop strategic alliances with major
pharmaceutical and biotechnology companies.


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                            CONTRACTUAL ARRANGEMENTS

         Most of the Company's contracts are fixed priced contracts that require
a portion of the contract amount to be paid at or near the time the trial is
initiated. The Company generally bills its clients upon the completion of
negotiated performance requirements and, to a lesser extent, on a date certain
basis. Most of the Company's contracts are subject to cost limitations which
cannot be exceeded without client approval. Because, in many cases, the Company
bears the risk of cost overruns, unbudgeted costs in connection with performing
these contracts may have a detrimental effect on the financial results of the
Company. If it is determined that a loss will result from the performance of a
contract, the entire amount of the estimated loss is charged against income in
the period in which the determination is made.

         The Company's contracts generally may be terminated with or without
cause. In the event of termination, the Company is typically entitled to all
sums owed for work performed through the notice of termination and all costs
associated with termination of the study. Once a trial has been commenced,
change orders may be requested by clients based on the results of the trial to
date, including changes in the scope of the trial and in the services to be
provided by the Company. Accordingly, compensation under a contract may increase
or decrease during the duration of a contract. The loss of a large contract or
the loss of multiple contracts, however, could adversely affect the Company's
future revenues and profitability. In addition, termination or delay in the
performance of a contract occurs for various reasons, including, but not limited
to, unexpected or undesired results, including unexpected or undesired results
from other studies not conducted by the Company, inadequate patient enrollment
or investigator recruitment, production problems resulting in shortages of the
drug being tested, adverse patient reactions to the drug being tested, or the
client's decision to de-emphasize a particular trial. The Company's service
contracts contain certain provisions designed to address the negative impact on
the Company's revenues and profitability as a result of non-controllable delays.
These provisions, however, may not be included in all of the Company's service
contracts. In any event, the Company attempts to negotiate reimbursement of
certain fees whether or not such provisions are included in the service
contract. The Company is not always successful in negotiating such
reimbursement. The delay of a large clinical trial, or multiple trials, could
adversely affect the Company's future revenues and profitability.

                                    CUSTOMERS

         The Company has in the past derived, and may in the future derive, a
significant portion of its net service revenue from a relatively limited number
of major projects or clients. Concentrations of business in the CRO industry are
not uncommon and are increasing as large pharmaceutical and biotechnology
companies are outsourcing larger clinical trials and large multiple site trials
to fewer full service CROs. For the year ended December 31, 1997, the Company's
top five customers accounted for approximately 38% of the Company's combined net
service revenue. One customer of the Company, a large international
pharmaceutical company with revenues in excess of $10 billion, accounted for
approximately 23% of net service revenues for the year ended December 31, 1997.
The Company believes that the loss of any of these customers, if not replaced or
if services provided to existing customers are not expanded, may have a material
adverse effect on the Company. There can be no assurance that the loss of any
such customers would be replaced or services to existing customers would be
expanded on terms acceptable to the Company.


                                       12
<PAGE>   13
                                     BACKLOG

         The Company reports backlog based on anticipated net revenues from
uncompleted projects which have been authorized by the client, through a written
contract or otherwise. Once work under a letter of intent or contract commences,
net service revenue is recognized over the life of the contract using the
percentage-of-completion method of accounting. In certain cases, the Company
will commence work on a project prior to finalizing a letter of intent or
contract. Contracts included in backlog are subject to termination or delay at
any time by the client or regulatory authorities. Termination or delays can
result from a number of factors, many of which are beyond the Company's control.
Delayed contracts remain in the Company's backlog pending determination of
whether to continue, modify or cancel the contract.

         The Company believes that its backlog as of any date is not necessarily
a meaningful indicator of future results and no assurance can be given that the
Company will be able to realize net service revenue included in backlog. As of
December 31, 1997, the Company's backlog was approximately $41 million compared
to approximately $25 million at December 31, 1996. One contract with Company's
largest client, which is currently delayed, accounted for approximately 60% of
the backlog at December 31, 1997. The Company anticipates that approximately 40%
of the December 31, 1997 backlog will be realized after December 31, 1998.

                                   COMPETITION

         The Company competes primarily against pharmaceutical companies' own
in-house research departments, other CROs and universities and teaching
hospitals. The CRO industry includes several hundred small, limited-service
providers, several medium-sized CROs, and a few full service global drug
development companies. The CRO industry is consolidating and, in recent years,
several large, full service competitors have emerged. This trend of industry
consolidation may result in greater competition among the larger CROs for
clients and possible candidates for further consolidation for these larger CROs.
Such large, full service competitors may have substantially greater capital,
technical and other resources, may be better known, and may have more
experienced personnel than the Company. The Company's major competitors include:
Covance, Inc.; Parexel International Corporation; Quintiles Transnational
Corporation; ClinTrials Research Inc.; Pharmaceutical Products Development
Corporation; Huntington Life Sciences Ltd.; Kendle International, Inc.; Phoenix
International Life Sciences, Inc.; and IBAH, Inc.

         CROs generally compete on the basis of previous experience, medical and
scientific expertise in specific therapeutic areas, specialty preclinical
capabilities, the quality of contract research, the ability to organize and
manage large-scale trials on a global basis, the ability to manage large and
complex medical databases, the ability to provide statistical and regulatory
services, the ability to recruit investigators, the ability to integrate
information technology with systems to improve the efficiency of contract
research, an international presence with strategically located facilities,
financial viability, and, in certain markets, price is a significant factor.


                                       13
<PAGE>   14

                        MICROINJECTION PATENT LICENSING

         The Company possesses an exclusive license to a U.S. patent awarded to
Ohio University, covering DNA Microinjection, which is utilized in providing its
specialty transgenic-based services.

         The Company grants sublicenses of its proprietary DNA Microinjection
technology, the process widely used in the pharmaceutical and biotechnology
industries to develop transgenic animals. These sublicenses entitle the Company
to receive revenues consisting of fees and, in certain cases, royalties.

         While the Company has retained the exclusive rights to use DNA
Microinjection for its drug development services, it has granted several
non-exclusive sublicenses for the use of DNA Microinjection in a variety of
applications, including the development, use and sale of other commercial
transgenic animal-based products and transgenic animal models. In those certain
instances where the Company grants a sublicense for commercial applications,
such as the use of a transgenic animal to produce therapeutic proteins, the
Company receives an annual license fee and revenue based royalties upon
commercialization of the transgenic animal-based products and services. In the
case of sublicenses for noncommercial applications, such as the use of
transgenic technology for basic in-house research purposes, the Company
generally receives an annual license fee. The Company will continue to license
this technology for the development of transgenic animals and transgenic animal
derived products which do not conflict with the specialty transgenic animal
services offered by the Company.

                              GOVERNMENT REGULATION

         The Company's operations are subject to numerous regulatory
requirements designed to assure the quality and integrity of its drug
development services. In recent years, these regulations have become more
numerous and stringent, reflecting an increased public concern about the dangers
of potentially toxic drugs, chemicals and other substances. To the extent that
the following information describes statutory or regulatory provisions, it is
qualified in its entirety by reference to the particular statutory and
regulatory provisions currently in effect. Any change in applicable law or
regulation may have a material effect on the business and prospects of the
Company.

         The industry standard for conducting biological testing is embodied in
regulations called "Good Laboratory Practices." GLP has been adopted by the
Environmental Protection Agency ("EPA") and the FDA in the United States and the
Minister des Affaires Sociales et de la Solidarite Nationale in France. GLP
stipulates requirements for facilities, equipment and professional staff. The
regulations mandate standardized procedures for controlling studies, for
recording and reporting data and for retaining appropriate records. The EPA, FDA
and any other governmental agency with the authority to control marketing
approval for new products can reject test results if they do not comply with
GLP. The Company monitors ongoing compliance with GLP standards. Additionally,
Organization of Economic Cooperation and Development ("OECD") member countries
(including France) must adopt GLP principles laid down by the OECD as indicated
in Directive 87/18/EEC.


                                       14
<PAGE>   15
         In addition, the Company is subject to scrutiny by many regulators
regarding its laboratories and materials. On the federal level in the United
States, the Company is regulated by the Department of Transportation,
Occupational Safety and Health Administration, Nuclear Regulatory Commission and
the Drug Enforcement Administration. At the state level, the Company is
monitored by the Commonwealth of Pennsylvania Department of Labor and Industry
and the Pennsylvania Department of Environmental Resources. In addition, certain
of the Company's European operations are subject to certain regulations in
France similar to the aforementioned federal and state regulations.

         In addition to the regulatory framework and GLP standards for
preclinical drug development services, the Company is and may be subject to
regulation under federal, state and foreign law, including requirements
regarding occupational safety, laboratory practices, the care and use of animals
in experimentation and testing, the use, handling and disposition of radioactive
materials, environmental protection and hazardous substance control, and may be
subject to other present and future local, state, federal and foreign
regulation, including future regulation of the preclinical drug development
industry, the biotechnology field and the biological testing industry.

         The clinical services provided by the Company are ultimately subject to
FDA regulation in the United States and comparable agencies in other countries,
although the level of applicable regulation in other countries is generally less
comprehensive than regulation present in the United States. The industry
standard for conducting clinical research and development studies is embodied in
regulations and guidelines called "Good Clinical Practices." Although the FDA
has not formally adopted a single GCP guideline, certain provisions of GCP have
been included in FDA regulations. In Europe, all work is carried out in
accordance with the EU Note For Guidance, "Good Clinical Practice for Trials on
Medicinal Products in the European Community." As a matter of practice, the FDA
and many other regulatory authorities require that test results submitted to
such authorities be based on studies conducted in accordance with GCP. These
regulations include: (i) complying with FDA regulations governing the selection
of qualified investigators; (ii) obtaining specific written commitments from the
investigators; (iii) verifying that the patient's informed consent is obtained;
(iv) monitoring the validity and accuracy of data; (v) verifying drug or device
accountability; and (vi) instructing investigators to maintain records and
reports. The Company must also maintain reports for each study for specified
periods for inspection by the study sponsor and the FDA and other applicable
regulatory authorities during audits. Non-compliance with GCP can result in the
disqualification of data collected during the clinical trial.

         The Company's standard operating procedures are written in accordance
with regulations and guidelines appropriate to the region where they will be
used. FDA regulations and guidelines serve as a basis for the North American
standard operating procedures. The Company has developed operating procedures in
accordance with local requirements and in harmony with the North American and
European operations. The Company has implemented common standard operating
procedures across geographic regions to assure consistency whenever it is
feasible and appropriate to do so. Complete external auditing services are
provided by the Company's U.S. and European operations.


                                       15
<PAGE>   16
                              INTELLECTUAL PROPERTY

         The Company has an exclusive commercial license to a U.S. patent
awarded to Ohio University in October 1989 covering DNA Microinjection, which is
the method of gene transfer widely employed for the successful development of
transgenic animals in several mammalian species. The Company has granted several
non-exclusive sublicenses for a variety of applications under this patent. The
Company, as it becomes aware of activities potentially infringing on its
commercial rights as the exclusive commercial licensee for the Ohio University
DNA Microinjection patent, takes appropriate action to curtail infringing
activities. There can be no assurance, however, that the Company's actions will
result in proof of infringement, curtailment of the potentially infringing
party's activities, or that the potentially infringing party will become
properly licensed and, thereby, financially obligated to the Company. Further,
there can be no assurance that technology circumventing the DNA Microinjection
process may not be developed in the future; nor can there be any assurance that
if such technology is developed that the Company would be able to continue to
practice the processes contained in the DNA Microinjection patent or that the
Company would be able to obtain licenses for such new technology on reasonable
terms, if at all. Outside of the U.S., the DNA Microinjection process is
non-proprietary; however, the commercialization of any products in the United
States using the DNA Microinjection process are protected by the patent. The
license has a term equal to the life of the last to expire of all patents
covered by the license, unless earlier terminated by either party for cause.

                        POTENTIAL LIABILITY AND INSURANCE

         The Company attempts to manage its potential liability by obtaining
indemnity provisions in its contracts with clients and with investigators hired
by the Company on behalf of its clients. These indemnities generally do not,
however, protect the Company against certain of its own actions such as those
involving negligence. Moreover, these indemnities are contractual arrangements
that are subject to negotiation with individual clients, and the terms and scope
of such indemnities can vary from client to client and from study to study.
Finally, the financial performance of these indemnities is not secured, so that
the Company bears the risk that an indemnifying party may not have the financial
ability to fulfill its indemnification obligations. In addition to such
indemnification provisions, the Company maintains limited coverage for
professional service liability insurance. The Company could be materially and
adversely affected if it were required to pay damages or incur defense costs in
connection with a claim that is outside the scope of an indemnity or in excess
of its insurance coverage or where the indemnity, although applicable, is not
performed in accordance with its terms.

         The Company believes that the risk of liability to patients in clinical
trials is mitigated by various regulatory requirements, including the role of
institutional review boards ("IRBs") and the need to obtain each patient's
informed consent. The FDA requires each human clinical trial to be reviewed and
approved by the IRB at each study site. An IRB is an independent committee that
includes both medical and nonmedical personnel and is obligated to protect the
interests of patients enrolled in the trial. After the trial begins, the IRB
monitors the protocol and the measures designed to protect patients, such as the
requirement to obtain informed consent.


                                       16
<PAGE>   17
                                     NEXTRAN

         On August 29, 1994, the Company, through a wholly-owned subsidiary,
entered into a Joint Venture Agreement (the "Joint Venture Agreement") with
Baxter Transplant Holdings, Inc. ("Holdings"), a wholly-owned subsidiary of
Baxter Healthcare Corporation ("Baxter"), which is a subsidiary of Baxter
International, Inc. ("Baxter International"). Under the Joint Venture Agreement,
the Company and Holdings formed Nextran, a Delaware general partnership
("Nextran"), in which the Company had a 30% partnership interest and Holdings
had a 70% partnership interest. In connection with the formation of Nextran, the
Company contributed $2.5 million in cash and certain rights under patent
licenses, research agreements, and other intangible assets related to its
xenograft (animal to human) organ transplantation and blood substitute programs,
including certain limited rights to practice under the DNA Microinjection patent
specifically within the xenograft and hemoglobin blood substitute fields of use.
In addition, the Company contributed laboratory and office space in Princeton,
New Jersey, swine research facilities near Athens, Ohio and certain related
equipment and other related assets with a net book value of $2.4 million to
Nextran. Baxter contributed to Nextran $20 million in cash and certain rights
under research and product marketing programs between Baxter and various third
parties related to certain of its transplantation programs.

         Pursuant to the terms of the Purchase Agreement, dated September 22,
1995, as amended, the Company consummated the sale of its 30% partnership
interest in Nextran to Transplant Acquisition Inc., a wholly-owned subsidiary of
Baxter, for a cash purchase price of $18 million. In connection with this
transaction, in the third quarter of 1995, the Company eliminated its investment
in Nextran and recorded an estimated nonrecurring gain, net of expenses, income
taxes and related accruals, of approximately $17.3 million. Additionally, in the
event that Nextran develops and commercializes hemoglobin blood substitutes
using technologies licensed to Nextran by the Company, the Company will receive
royalty income of 3% of end product sales.

                        RESEARCH AND DEVELOPMENT EXPENSES

         As the result of the sale of the Company's interest in Nextran, as well
as the change in the strategic focus of the Company, the Company's research and
development expenses have decreased significantly since 1994.

                                    EMPLOYEES

         As of December 31, 1997, the Company employed 450 individuals on a
full-time basis. None of the Company's U.S. employees are represented by trade
unions. All of the employees of its European preclinical operations, except
senior management, are represented by a legal trade union. These employees are
governed by an agreement, which is subject to renegotiation on an annual basis.
Although no employees of the European clinical operations are covered by a trade
union, many of them have written contracts with the Company in accordance with
local law. The Company believes that it maintains good relations with its
employees.


                                       17
<PAGE>   18
                          BUSINESS SEGMENT INFORMATION

         For information on amounts of revenue, operating profit and loss and
identifiable assets attributable to the Company's operations, see Note 18 of the
Notes to Consolidated Financial Statements included in Part IV of this Annual
Report on Form 10-K.

ITEM 2.  PROPERTIES

         The Company's corporate headquarters is located in Raritan, New Jersey.
The Company, under an option provision of the lease agreement, extended its
lease on this facility through February 1999. The lease includes another renewal
option for an additional one year period which would expire in February 2000.

         The Company's U.S. preclinical operations are located in two adjacent
facilities near Scranton, Pennsylvania. One facility is approximately 21,000
square feet and is leased through August 1999. The other, a 20,000 square foot
facility, is owned subject to a mortgage. The Company owns and operates
approximately 100,000 square feet of facilities on approximately nine acres near
Lyon, France for its preclinical operations in Europe. The Company has an option
to purchase land adjacent to these facilities.

         The Company's specialty transgenic services business operates in
Princeton, New Jersey. The Company leases a facility for administrative offices
and research laboratories. This lease expires in May 2000. The Company is
pursuing alternative facilities to accommodate its expanding business in
transgenic services. Additionally, the Company shares an adjacent facility
pursuant to an agreement with Nextran, regarding its transgenic services
operations, which remains in force until August 1999.

         The Company's U.S. clinical operations are conducted in a leased
facility in Austin, Texas, which lease expires in February 2001. The Company
leases its European clinical headquarters in Cham, Switzerland, which lease
expires in March 2000. The Company also maintains offices in Canada; Mannheim,
Germany; France; Belgium; The Netherlands; the United Kingdom; Sweden; Denmark;
Norway; Finland; Spain; Italy; Israel; Vilnius, Lithuania; Poland; Russia; and
the Ukraine for its clinical operations.

         The Company also leases a facility in Dusseldorf, Germany which is
utilized for Phase I and Phase II trials and is the information systems, data
management and biostatistical center. This lease expires in August 2001.

         The Company believes that the space it leases is adequate for its
current operations and that the leases generally reflect market rates in their
respective geographic areas.


ITEM 3.  LEGAL PROCEEDINGS

         The Company is not a party to any material legal proceedings.


                                       18
<PAGE>   19
ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

         No matter was submitted to a vote of security holders during the fourth
quarter of the fiscal year covered by this Annual Report on Form 10-K.

ITEM 4A.  EXECUTIVE OFFICERS OF THE COMPANY

         The information under this Item 4A is furnished pursuant to Instruction
3 to Item 401(b) of Regulation S-K.

         PAUL J. SCHMITT, CHAIRMAN OF THE BOARD, PRESIDENT AND CHIEF EXECUTIVE
OFFICER. Mr. Schmitt has served as Chairman of the Board of Directors since
October 1994. Mr. Schmitt joined the Company as President and Chief Executive
Officer in November 1988. Mr. Schmitt was elected as a Director of the Company
in November 1988. From May 1986 to October 1988, Mr. Schmitt was President of
Biolectron, Inc., a medical device company. Prior to joining Biolectron, Mr.
Schmitt was with the BOC Group, PLC, an industrial gas and health care company,
where, from October 1981 until May 1986, he served as Vice President and General
Manager in BOC's health care group. Mr. Schmitt received his B.S. degree in
finance from Lehigh University and his M.B.A. degree from Rutgers University.
Mr. Schmitt is 46 years old.

         JACK BARBUT, SC.D., VICE CHAIRMAN AND PRESIDENT, CLINICAL SERVICES. In
connection with the Acquisition in December 1996, Dr. Barbut was appointed as
Vice Chairman and President, Clinical Services of the Company and was elected to
the Board of Directors of the Company. Prior to the Acquisition, Dr. Barbut
founded the BioClin Group in 1979 and oversaw its operations thereafter. Dr.
Barbut received his Sc.D. degree in systems engineering from The Polytechnic
Institute in Lausanne, Switzerland. Dr. Barbut is 45 years old.

         JOHN G. COOPER, SENIOR VICE PRESIDENT AND CHIEF FINANCIAL OFFICER. Mr.
Cooper has served as Senior Vice President and Chief Financial Officer of
Chrysalis since June 1996. He was Vice President, Chief Financial Officer,
Treasurer and Secretary from February 1991 to June 1996 and has been the
Company's principal financial officer since January 1989. Prior to joining the
Company, Mr. Cooper served in several senior corporate financial management
positions for Pharmacia ENI, Inc., a public medical diagnostics company, since
March 1984. Previously, Mr. Cooper held financial positions with C.R. Bard,
Inc., a health care company, from July 1982 to March 1984. Mr. Cooper is a
Certified Public Accountant and received his B.S. degree in commerce from Rider
University. Mr. Cooper is 39 years old.

         LEIF MODEWEG, D.V.M., PRESIDENT, PRECLINICAL SERVICES. Dr. Modeweg has
served as President of Preclinical Services of the Company since September 1,
1994. Dr. Modeweg has also served as President of the European preclinical
operations since December 1992. From June 1989 to December 1992, he served as
Managing Director of Hazleton France, predecessor to the European preclinical
operations. From 1980 to 1989, Dr. Modeweg was employed by BioResearch
Laboratories, a contract preclinical drug development services organization in
Montreal, Canada, and served as Vice President from 1988 to 1989. From 1972 to
1980, he served as a toxicologist and department head for Toxicology for Novo
Industri A/S, the leading pharmaceutical company in Denmark. Previously, Dr.
Modeweg


                                       19
<PAGE>   20
was employed by the Danish Institute for Biochemical Research and Development.
Dr. Modeweg received his D.V.M. degree from the Royal Veterinary University,
Copenhagen, Denmark. Dr. Modeweg is 60 years old.

         J. CHRISTIAN JENSEN, PH.D., PRESIDENT, INTERNATIONAL SERVICES. In
connection with the Acquisition in December 1996, Dr. Jensen was appointed as
President, International Services of the Company and was elected to the Board of
Directors of the Company. Dr. Jensen joined the BioClin Group in 1991 and, prior
to the Acquisition, served as President of the BioClin Group's European
operations and Chief Operating Officer of the BioClin Group. Dr. Jensen served
as Human Pharmacology Expert from 1989 to 1991 and Pharmacological and Medical
Expert from 1986 to 1989 at Sandoz Pharma Ltd. From 1981 to 1986 he was a
pharmacologist and toxicologist at the University of Bonn Medical Clinics. In
1986, Dr. Jensen became an associate professor of Clinical Pharmacology at the
University of Bonn and received his B.S. degree in Biology from Baker University
and a Ph.D. degree in Pharmacology and Toxicology from the University of Kansas.
Dr. Jensen is 47 years old.

         There exists no arrangement or understanding between any executive
officer and any other person pursuant to which such executive officer was
appointed. Each executive officer serves until their successor is duly appointed
and qualified.

                                     PART II

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

         As of the close of business on March 20, 1998 there were 4,013 holders
of record of Common Stock. The Company has not declared or paid any cash
dividends on shares of its equity securities, including Common Stock, since its
incorporation in 1988. The Company currently intends to retain its earnings, if
any, to finance its future development and growth and therefore does not
anticipate paying any cash dividends on its capital stock in the foreseeable
future.

         The Common Stock is traded on The Nasdaq National Market. The symbol
currently is CRLS. Prior to December 18, 1996, the Company's trading symbol was
DNXX.

         The Company's Common Stock commenced trading on December 11, 1991. The
table below sets forth the high and low closing prices by quarter during 1997
and 1996.

<TABLE>
<CAPTION>
QUARTER 1997          HIGH          LOW        QUARTER 1996          HIGH         LOW
------------          ----          ---        ------------          ----         ---
<S>               <C>           <C>            <C>                 <C>         <C>
    1ST           $5-15/16      $4-7/16            1ST             $5-3/4      $3-1/2
    2ND                  5       4-1/16            2ND              8-1/2       4-1/4
    3RD              4-1/2       3-7/16            3RD              6-5/8       4-5/8
    4TH              4-3/8       2-1/16            4TH              5-3/4           4
</TABLE>


                                       20
<PAGE>   21
ITEM 6.  SELECTED FINANCIAL DATA

<TABLE>
<CAPTION>
                                                                     YEARS ENDED DECEMBER 31,
                                                        1997        1996       1995       1994       1993
                                                      --------     ------     ------     ------     ------
STATEMENT OF OPERATIONS DATA:                                  (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                                   <C>          <C>        <C>        <C>        <C>
Net revenues                                          $ 42,298     41,487     39,609     36,188     30,894
Operating costs and expenses:
    Direct costs                                        29,217     27,313     27,691     25,499     22,342
    Research and development                               166        528      1,063      3,940      9,876
    General, administrative and marketing               12,416     10,942      9,631      9,975      9,515
    Depreciation and amortization                        2,699      2,780      2,907      3,594      3,683
    Special charge(1)                                       --         --         --         --      7,095
    Business combination costs(2)                           --      3,649         --         --         --
                                                      --------     ------     ------     ------     ------
                                                        44,498     45,212     41,292     43,008     52,511
    Loss from operations                                (2,200)    (3,725)    (1,683)    (6,820)   (21,617)
                                                      --------     ------     ------     ------     ------
    Other income (expense), net                            390        742       (635)      (525)      (231)
    Net loss before equity in net loss of Nextran,
        gain on sale of Nextran and taxes               (1,810)    (2,983)    (2,318)    (7,345)   (21,848)
    Equity in net loss of Nextran(3)                        --         --      2,700      1,329         --
    Gain on sale of Nextran, net of income taxes(3)         --         --     17,266         --         --
    Income tax expense (benefit)                           240        477       (177)       390        (22)
                                                      --------     ------     ------     ------     ------
        Net income (loss)                             $ (2,050)    (3,460)    12,425     (9,064)   (21,826)
                                                      ========     ======     ======     ======     ======
    Basic earnings (loss) per share                   $  (0.18)     (0.31)      1.12      (0.82)     (1.99)
                                                      ========     ======     ======     ======     ======
    Diluted earnings (loss) per share                 $  (0.18)     (0.31)      1.06      (0.82)     (1.99)
                                                      ========     ======     ======     ======     ======
BALANCE SHEET DATA:
    Cash, cash equivalents and investments            $  6,925     13,470     23,102      6,234     14,592
    Restricted cash                                        460      5,010        777      1,724      1,430
    Accounts receivable, net                             9,669     10,788     10,907      9,340      7,546
        Property, equipment and leasehold
        improvements, net                               15,127     15,963     17,806     18,548     19,391
    Intangible assets, net                                 805        953      1,035        991      1,252
    Investment in Nextran(3)                                --         --         --      3,844         --
    Other assets                                         2,254      1,759      1,797      1,454      2,377
                                                      --------     ------     ------     ------     ------
        Total assets                                  $ 35,240     47,943     55,424     42,135     46,588
                                                      ========     ======     ======     ======     ======

    Current liabilities, excluding debt                 12,295     17,501     15,292     16,047     13,443
    Short-term debt                                      2,668     11,238     11,559      9,876      8,145
    Current portion of long-term debt                      768        180        744        784      3,691
    Long-term debt, excluding current portion            6,561      2,376      7,830      8,502      6,131
    Deferred income taxes                                1,646      2,053      2,059      2,075      1,965
    Other liabilities                                      633      1,054        948      1,180      1,758
    Total stockholders' equity                          10,669     13,541     16,992      3,671     11,455
                                                      --------     ------     ------     ------     ------
        Total liabilities and stockholders' equity    $ 35,240     47,943     55,424     42,135     46,588
                                                      ========     ======     ======     ======     ======
</TABLE>

----------
(1)  In 1993, the Company initiated a plan to suspend research and development
     efforts on its hemoglobin blood substitute program and thereby downsized
     and reorganized its operations. In accordance with this decision, the
     Company recorded a special charge of $7.1 million.

(2)  In the fourth quarter of 1996, the Company recorded business combination
     costs of approximately $3.6 million for costs incurred as a result of its
     acquisition of the clinical drug development business on December 18, 1996.
     See Note 5 of the Notes to Consolidated Financial Statements included in
     Part IV of this Annual Report on Form 10-K.

(3)  On August 29, 1994, the Company, through a wholly-owned subsidiary, entered
     into a Joint Venture Agreement with Baxter to form Nextran, a partnership
     in which the Company had a 30% partnership interest. On September 22, 1995,
     the Company consummated the sale of its 30% partnership interest in Nextran
     to Transplant Acquisition Inc. for a cash purchase price of $18 million. As
     a result of the sale of its partnership interest in Nextran, the Company
     recorded a nonrecurring gain, net of expenses, income taxes and related
     accruals of approximately $17.3 million. See Note 7 of the Notes to
     Consolidated Financial Statements included in Part IV of this Annual Report
     on Form 10-K.


                                       21
<PAGE>   22
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS

GENERAL SUMMARY

         The Company is an international CRO providing a broad range of
integrated drug development services primarily to the pharmaceutical and
biotechnology industries. This broad portfolio of drug development services
includes transgenic discovery research, preclinical development and clinical
capabilities that enable the Company to manage a comprehensive drug development
program or a client's specific requirements. The Company utilizes its
international expertise and experience in preclinical and clinical services to
provide a coordinated approach for a client to transition its drug through
various preclinical to clinical stages of development thereby minimizing certain
delays which typically occur before a new drug is introduced to the market. In
addition, the Company is the only CRO that is currently able to use its
proprietary transgenic and licensed gene targeting technology to provide
services for its clients that require transgenic animal models in order to
determine the function of human genes and identify therapeutic targets
implicated in disease and for the evaluation of therapeutic lead compounds for
further development. The Company generates substantially all of its revenues
from its drug development services and provides services for more than 250
clients in 26 countries.

         On March 16, 1998, the Company issued a $5.0 million subordinated
debenture to a wholly-owned subsidiary of MDS. As part of this transaction, the
Company also issued a warrant to purchase 2,000,000 shares of Common Stock for
$2.50 per share. In addition, the Company and MDS entered into a standstill
agreement which, among other things, governs the ownership and acquisition of
securities of the Company by MDS and its affiliates. As a part of this
transaction, MDS and the Company will explore opportunities to pursue strategic
alliances and other business opportunities with respect to their respective
operations.

         On December 18, 1996, the Company issued 2,632,600 shares of Common
Stock in connection with the Acquisition by the Company of all of the
outstanding capital stock of, or equity interests in, BioClin, Inc., a Delaware
corporation, BioClin Europe AG, a Swiss corporation, BioClin GmbH, a German
corporation, Kilmer N.V., a Netherlands Antilles corporation, and BioClin
Institute of Clinical Pharmacology GmbH, a German corporation. The Acquisition
was recorded using the "pooling-of-interests" method of accounting. In
connection with the Acquisition, the Company incurred business combination costs
aggregating approximately $3.6 million.

         Chrysalis is also the exclusive commercial licensee of a U.S. patent
covering DNA Microinjection, the process widely used in the pharmaceutical and
biotechnology industries to develop transgenic animals. The Company utilizes
this license for its drug development services and grants sublicenses for the
use of this technology. These sublicenses entitle the Company to receive
revenues consisting of fees and, in certain cases, royalties.

         The Company's financial statements are denominated in U.S. dollars and,
accordingly, changes in the exchange rate between non-U.S. currencies and the
U.S. dollar will affect the translation of non-U.S. revenues and operating
results into U.S. dollars for purposes of reporting the Company's financial
results. For the year ended December 31, 1997, approximately 63% of


                                       22
<PAGE>   23
the Company's revenues were from operations outside the U.S. Approximately 44%
of the Company's revenues for the year ended December 31, 1997 were from
operations in France and denominated in French Francs; accordingly, fluctuations
in the exchange rate between the French Franc and the U.S. dollar may have a
material effect on the Company's operating results. See " -- Liquidity and
Capital Requirements -- Exchange Rate Fluctuations."

         In addition, the Company may be subject to foreign currency transaction
risk when the Company's multi-country contracts are denominated in a currency
other than the currency in which the Company incurs the expenses related to such
contracts. For such multi-country contracts, the Company seeks to require its
client to incur the effect of fluctuations in the relative values of the
contract currency and the currency in which the expenses are incurred. To the
extent the Company is unable to require its clients to incur the effects of
currency fluctuations, these fluctuations could have a material effect on the
results of operations of the Company. The Company does not currently hedge
against the risk of exchange rate fluctuations.

         The Company's contracts are typically fixed price contracts that
require a portion of the contract amount to be paid at or near the time the
trial is initiated. The Company generally bills its clients upon the completion
of negotiated performance requirements and, to a lesser extent, on a date
certain basis. Certain of the Company's contracts are subject to cost
limitations which cannot be exceeded without client approval. Because, in many
cases, the Company bears the risk of cost overruns, unbudgeted costs in
connection with performing these contracts may have a detrimental effect on the
financial results of the Company. If it is determined that a loss will result
from the performance of a contract, the entire amount of the estimated loss is
charged against income in the period in which the determination is made.

         The Company's contracts generally may be terminated with or without
cause. In the event of termination, the Company is typically entitled to all
sums owed for work performed through the notice of termination and all costs
associated with termination of the study. In addition, most of the Company's
contracts provide for an early termination fee, the amount of which usually
declines as the work progresses. The Company's service contracts also contain
certain provisions designed to address the negative impact on the Company's
revenues and profitability as a result of non-controllable delays. These
provisions, however, may not be included in all of the Company's service
contracts. In any event, the Company attempts to negotiate reimbursement of
certain fees whether or not such provisions are included in the service
contract. The Company is not always successful in negotiating such
reimbursement. The loss of or delay in a large contract or the loss of multiple
contracts, however, could adversely affect the Company's future revenues and
profitability. In addition, termination or delay in the performance of a
contract occurs for various reasons, including, but not limited to, unexpected
or undesired results, inadequate patient enrollment or investigator recruitment,
production problems resulting in shortages of the drug being tested, adverse
patient reactions to the drug being tested, or the client's decision to not
proceed with a particular trial.

         Revenue for contracts is recognized on a percentage of completion basis
as work is performed. Revenue is affected by the mix of trials conducted and the
degree to which effort is expended. The Company will incur travel costs and may
subcontract with third-party investigators in connection with multi-site
clinical trials. These costs are passed through to clients and, in accordance
with industry practice, are included in service revenue. The costs may vary
significantly from contract to contract; therefore, changes in service revenue
may not be indicative


                                       23
<PAGE>   24
of trends in revenue growth. Accordingly, the Company considers net service
revenue, which consists of service revenue less these costs, as its primary
measure of revenue growth.

         The Company has had, and will continue to have, certain clients from
which at least 10% of the Company's overall revenue is generated over multiple
contracts. Such concentration of business is not uncommon within the CRO
industry. For the year ended December 31, 1997, the Company's top five customers
accounted for approximately 38% of its combined net service revenue. One
customer, one of the world's leading pharmaceutical companies, accounted for
approximately 23% of the Company's net service revenues in fiscal 1997. The
Company believes that the loss of any of these customers, if not replaced or if
services provided to existing customers are not expanded, may have a material
adverse effect on the Company. There can be no assurance that the loss of any
such customer would be replaced or services to existing customers would be
expanded on terms acceptable to the Company.

         The Company has incurred expenses during 1997 expanding its
infrastructure, primarily in the clinical operations, to support global drug
development capabilities and utilizing management's resources primarily to
communicate these expanded capabilities to its existing client base and the
pharmaceutical and biotechnology industries. As a result of these efforts, the
Company believes it is capable of supporting higher revenues. However, the
Company's future operating results will be contingent upon successfully
utilizing this expanded infrastructure which will require the Company to convert
proposals into contracts and revenues. There can be no assurance that the
Company will be able to successfully utilize its expanded infrastructure or that
proposals will be converted into revenues in a timely manner. The Company's
ability to utilize its expanded infrastructure in order to enhance future
operating results may also be affected by factors such as delays in initiating
or completing significant preclinical and clinical trials, the lengthening of
lead times to convert proposals into contracts and revenues, and the termination
of preclinical and clinical trials, all of which may be beyond the control of
the Company. See " -- Quarterly Results."

         The Company's quarterly operating results may fluctuate as a result of
various factors, such as delays experienced in implementing or completing
particular services and termination of services. Since a substantial portion of
the Company's operating costs are relatively fixed, while revenue is subject to
fluctuations, minor variations or delays in the timing of services or the
progress of services may cause significant variations in quarterly operating
results. Results of one quarter are not necessarily indicative of results for
the next quarter.

         The Company's largest client, a leading pharmaceutical company,
notified the Company that it decided to change a clinical protocol and thereby
delay a large clinical trial which was originally expected to begin during the
fourth quarter of 1997. As a result, consistent with management's expectations,
results during the fourth quarter of 1997 were negatively impacted. As a result
of this delay and the strategic decision to maintain clinical infrastructure
utilized for this contract and to position Chrysalis for growth opportunities,
revenues and earnings in the first half of 1998 will be significantly affected.
The Company has been informed that this client currently anticipates a decision
on the commencement of this trial in the second quarter of fiscal 1998.

         On August 29, 1994, the Company, through a wholly-owned subsidiary,
entered into the Joint Venture Agreement with Holdings, a wholly-owned
subsidiary of Baxter, which is a subsidiary of Baxter International. Under the
Joint Venture Agreement, the Company and Holdings formed Nextran, a Delaware
general partnership, in which the Company had a 30%


                                       24
<PAGE>   25
partnership interest and Holdings had a 70% partnership interest. Pursuant to
the terms of the Purchase Agreement, dated September 22, 1995, as amended, the
Company consummated the sale of its 30% partnership interest in Nextran to
Transplant Acquisition Inc., a wholly-owned subsidiary Baxter, for a cash
purchase price of $18 million. As a result of these transactions, the Company is
no longer required to use its resources to fund the development of its organ
transplantation or blood substitute programs. Historically, these programs have
accounted for a substantial portion of the Company's research and development
expenses, capital expenditures, working capital and accumulated deficit. Prior
to the sale of its partnership interest in Nextran, the Company recorded its
share of Nextran's financial results of operations in its consolidated financial
statements according to the equity method of accounting.

RESULTS OF OPERATIONS

REVENUES BY BUSINESS AND GEOGRAPHIC REGION

<TABLE>
<CAPTION>
                          REVENUES ($000'S)
                     1997       1996       1995
                    ------     ------     ------
<S>                 <C>        <C>        <C>
Preclinical         27,259     29,090     24,396
Clinical            14,243     11,883     14,286
Licensing/Other        796        514        927
                    ------     ------     ------
  Total             42,298     41,487     39,609
                    ======     ======     ======

International       26,778     28,322     24,890
North America       14,724     12,651     13,792
Licensing/Other        796        514        927
                    ------     ------     ------
  Total             42,298     41,487     39,609
                    ======     ======     ======
</TABLE>

         Fiscal year ended December 31, 1997 as compared to the fiscal years
ended December 31, 1996 and 1995.

         Revenues. Revenues were $42,298,000 for 1997 compared to $41,487,000
and $39,609,000 for 1996 and 1995, respectively. For the year ended December 31,
1997, the Company generated approximately 63% of its revenues from operations
outside of the U.S. Excluding the impact of foreign currency translations,
revenues for the year ended December 31, 1997 would have been approximately
$46,204,000 as compared to $41,487,000 for 1996. See " -- Liquidity and Capital
Requirements - Exchange Rate Fluctuations." This increase from 1996 to 1997 was
primarily the result of the following: (i) an increase in the clinical business
including services provided under contracts with the Company's largest customer;
(ii) an increase in the Company's specialty transgenic and molecular biology
services; and (iii) an increase in preclinical business in Europe. These
increases were offset by the unfavorable impact of foreign currency translations
as well as by a decrease in the preclinical business in North America, and the
Phase I clinical business in Europe. Additionally, revenues in 1997 were
negatively impacted by a delay in a large clinical trial which was originally
expected to begin in the fourth quarter of 1997. The Company believes that
revenue growth for the clinical business for the year ended December 31, 1997
was also adversely affected as a result of (i) the long lead times in converting
proposals into contracts and revenues and (ii) in the first half of 1997, the
continuing impact, as a result of such long lead times, of the focus of senior
management in the clinical business in the negotiation and


                                       25
<PAGE>   26
consummation of the Acquisition during 1996 and, consequently, having less
opportunity to devote to business development and marketing the clinical
business.

         The Company's largest client, a leading pharmaceutical company,
notified the Company that it decided to change a clinical protocol and thereby
delay a large clinical trial which was originally expected to begin during the
fourth quarter of 1997. As a result, consistent with management's expectations,
results during the fourth quarter of 1997 were negatively impacted. As a result
of this delay and the strategic decision to maintain clinical infrastructure
utilized for this contract and to position Chrysalis for growth opportunities,
revenues and earnings in the first half of 1998 will be significantly affected.
The Company has been informed that this client currently anticipates a decision
on the commencement of this trial in the second quarter of fiscal 1998.

         The increase in revenues from 1995 to 1996 was due to an increase in
business activity for the preclinical drug development services in both the
European and U.S. marketplace. This increase in preclinical services was offset
by a decrease in revenues from clinical services. The Company believes the
increase in preclinical business activity was a result of the improvement in the
pharmaceutical and biotechnology industries outsourcing trends and expanded cash
reserves within the biotechnology sector. The decrease of approximately
$2,400,000 in revenues for the clinical business was due to the decision in 1995
to discontinue providing services for Phase I trials in the U.S. which
represented approximately $3,500,000 in revenues for the clinical business in
1995. In addition, revenues for the clinical business in 1996 were adversely
affected by senior managements' involvement in the negotiation and consummation
of the Acquisition and, consequently, having less opportunity than in 1995 to
devote to business development and marketing the clinical business.

         Operating Expenses. Direct costs were $29,217,000 or 69% of net
revenues for 1997, compared with $27,313,000 or 66% of net revenues for 1996.
For 1995 direct costs were $27,691,000 or 70% of net revenues. Excluding the
impact of foreign currency translations, this increase in direct costs of
$1,904,000 for the year ended December 31, 1997, as compared to the same period
in 1996, would have been approximately $4,491,000. This increase in direct costs
was primarily due to (i) investment in personnel and infrastructure to support
the long-term business expansion strategy of the Company and to accommodate the
large clinical trial with a leading pharmaceutical company which was delayed in
the last quarter of 1997 (See " -- General Summary") and (ii) increased variable
costs as a result of increased business activity in the Company's European
preclinical services and specialty transgenic and molecular biology services in
1997. The increase in these costs as a percent of revenues is due to a base cost
structure of personnel, facilities, and related expenses which is capable of
supporting a higher level of revenues than experienced during the year ended
December 31, 1997. This relationship of direct costs to revenues is expected to
continue at least through the first half of 1998, as the Company will retain the
majority of its recently expanded infrastructure to better position the Company
for long-term growth.

         Although direct costs remained relatively unchanged on a Company-wide
basis for 1996 as compared to 1995, direct costs associated with preclinical
business increased as a result of additional business activity, which resulted
in an increase in variable costs such as materials and supplies, offset by a
decrease in direct costs for the clinical business primarily due to the decision
to discontinue providing services for Phase I trials in the U.S.


                                       26
<PAGE>   27
         Research and development expenses in 1997 decreased to $166,000 from
$528,000 in 1996, which decreased from $1,063,000 in 1995. This decrease in
research and development expenses over the past three years was primarily the
result of the shift in the strategic focus of the Company's transgenic animal
services from the internal development of transgenic animal models to providing
commercial specialty drug development services. Because research and development
expenses have become immaterial primarily as a result of the shift in the
strategic focus and the related decline in costs, research and development
expenses shown for reporting purposes in prior periods will be reclassified in
1998 into direct costs.

         General, administrative and marketing expenses increased to $12,416,000
in 1997 from $10,942,000 in 1996, which increased from $9,631,000 in 1995.
Excluding the impact of foreign currency translation, this increase of
$1,474,000, for the period ended December 31, 1997, as compared to the same
period in 1996, would have been approximately $2,590,000. This increase in
expenses for 1997 was primarily due to: (i) the increase in personnel and
related costs for marketing and business development, information systems,
general management and financial management activities, (ii) the increase in
personnel and related costs associated with the management of the European
clinical business, and (iii) the increase in personnel and facility costs
associated with the increase in the Company's specialty transgenic and molecular
biology services. The increase in these expenses from 1995 to 1996 was primarily
the result of an increase in costs for expansion of operations in Eastern
Europe, additional personnel for accounting, business development,
administration and information systems, increased personnel related costs and
increased sales, marketing and advertising expenses.

         Depreciation and amortization decreased to $2,699,000 in 1997 from
$2,780,000 in 1996 and $2,907,000 in 1995.

         Business Combination Costs. The Company incurred costs in 1996
associated with the Acquisition aggregating $3,649,000. These costs included
expenses associated with the acquisition of the clinical business, the name
change from DNX Corporation to Chrysalis and certain other related items. As of
December 31, 1996, $1,380,000 of these costs remained to be paid and are
classified as accrued expenses in the Consolidated Financial Statements included
in Part IV of this Annual Report on Form 10-K.

         Other Income (Expense). Other income (expense) represented income of
$390,000 in 1997, compared to income of $742,000 for 1996, and expense of
$635,000 for 1995. This decrease from 1996 to 1997 was partially due to a
decrease in interest expense resulting from lower outstanding debt balances (see
" -- Liquidity and Capital Requirements -- Debt") offset by a decrease in
interest income earned in 1997 as a result of a decrease in cash and other
investment balances. Also included in other income in 1997 was a $700,000
nonrecurring gain resulting from a settlement agreement with Virginia
Commonwealth University, signed in the third quarter of 1997. The primary
reasons for the improvement in other income (expense) in 1996 from 1995 were
interest income of $1,187,000 earned as the result of higher cash balances
primarily resulting from the sale of Nextran in the third quarter of 1995 and a
foreign currency gain of $517,000 primarily as a result of exchange rate
fluctuations between the German Mark and Swiss Franc associated with short-term
borrowings of the Company's German operations denominated in Swiss Francs. The
Company repaid this debt denominated in Swiss Francs in 1997. Such income was
offset primarily by interest expense of $1,445,000 on outstanding debt. In 1998,
the Company expects to report an


                                       27
<PAGE>   28
increase in net interest expense as a result of the issuance of the subordinated
debenture and the warrants in the transaction with MDS.

         Equity In Net Loss Of Nextran. As a result of its minority equity
ownership in Nextran, the Company recorded its share of Nextran's financial
results in its consolidated financial statements based on the equity method of
accounting. As a result of the sale of its partnership interest in Nextran, the
Company no longer records a share of Nextran's financial results of operations
in its consolidated financial statements subsequent to September 30, 1995. The
Company's share of Nextran's loss amounted to $2,700,000 for the period ended
September 30, 1995, as compared to $1,329,000 for the period from August 29,
1994 (the date of formation of Nextran) through December 31, 1994.

         Gain on Sale of Nextran. As a result of the sale of its partnership
interest in Nextran, in the third quarter of 1995 the Company eliminated its
investment in Nextran and recorded a nonrecurring gain, net of expenses,
estimated income taxes of $200,000, and related accruals, of $17,266,000.

         Taxes. The Company's foreign subsidiaries are subject to foreign income
taxes under foreign tax laws on the profits generated in such countries which in
general may not be offset by losses from operations in other countries. As a
result, primarily for its French operations, the Company recorded an income tax
expense of $240,000 in fiscal 1997 compared to an income tax expense in 1996 of
$477,000 and an income tax benefit in 1995 of $177,000. These expenses are
primarily due to profits generated by its French operations partially offset by
tax benefits recorded as a result of losses in other European operations.

         The impact from United States federal income taxes is currently not
significant due to the Company's available net operating loss carryforwards. At
December 31, 1997, the Company has available net operating loss carryforwards of
approximately $26,434,000 for United States federal income tax purposes. Such
loss carryforwards expire through 2012. The Company also has research and
development tax credit carryforwards of approximately $3,012,000 for U.S.
federal income tax reporting purposes which are available to reduce U.S. federal
income taxes, if any, through 2011. The Company has alternative minimum tax
credit carryforwards of approximately $164,000 for U.S. federal income tax
purposes which are available to reduce U.S. federal income taxes, if any. These
tax credits have an unlimited carryforward period. The Company's acquisition of
the clinical drug development business resulted in an ownership change under the
Internal Revenue Code of 1986, as amended (the "Code"). Accordingly, the
Company's ability to utilize its net operating loss carryforwards to offset
operating profits may be subject to certain limitations in the future under the
Code. These net operating loss carryforwards may not be utilized to offset
profit in other countries.

QUARTERLY RESULTS

         The Company's quarterly operating results are subject to variation, and
are expected to continue to be subject to variation, as a result of factors such
as delays in initiating or completing significant preclinical and clinical
trials, termination of preclinical and clinical trials, acquisitions and
exchange rate fluctuations. Delays and terminations of studies or trials are
often the result of actions taken by clients or regulatory authorities and are
not typically subject to the control of the Company. Since a large amount of the
Company's operating costs are relatively fixed while its


                                       28
<PAGE>   29
revenues are subject to fluctuation, minor variations in the commencement,
progress or completion of preclinical and clinical trials may cause significant
variations in quarterly operating results.

         The following table presents unaudited quarterly operating results for
each of the fiscal quarters of 1997. In the opinion of the Company, this
information has been prepared on the same basis as the audited consolidated
financial statements and reflects all adjustments (consisting only of normal
recurring adjustments) necessary for a fair presentation of results of
operations for those periods. This quarterly financial data should be read in
conjunction with the consolidated audited financial statements and notes thereto
included in Part IV of this Annual Report on Form 10-K. The operating results
for any quarter are not necessarily indicative of the results to be expected in
any future period.

<TABLE>
<CAPTION>
                                                      QUARTER ENDED ($000'S)
                                                            (UNAUDITED)
                                         -----------------------------------------------
                                         MARCH 31,     JUNE 30,     SEPT. 30,    DEC. 31,
                                           1997          1997         1997         1997
                                         --------      -------      -------      -------
<S>                                      <C>           <C>          <C>          <C>
Net revenues                             $  9,905       10,145       10,623       11,624
Operating expenses:
         Direct costs                       6,970        7,054        7,392        7,802
         Research and development              52           47           31           36
         General, administrative and        2,874        2,976        3,123        3,442
           marketing
         Depreciation and
           amortization                       638          654          708          699
                                         --------      -------      -------      -------
                                           10,534       10,731       11,254       11,979
Loss from operations                         (629)        (586)        (631)        (355)
Other income (expense):
         Interest income                      181          123           93           72
         Interest expense                    (191)        (165)        (206)        (213)
         Foreign currency gain                 --           --           --           11
         Other                                  4           (6)         692           (4)
                                         --------      -------      -------      -------
                                               (6)         (48)         579         (134)
                                         --------      -------      -------      -------
Loss before income taxes                     (635)        (634)         (52)        (489)
Income tax expense                             (9)         (31)         (41)        (159)
                                         --------      -------      -------      -------
Net loss                                 $   (644)        (665)         (93)        (648)
                                         ========      =======      =======      =======
</TABLE>


REVENUES BY BUSINESS AND GEOGRAPHIC REGION BY QUARTER

<TABLE>
<CAPTION>
                             QUARTER ENDED ($000'S)
                                  (UNAUDITED)
                   ----------------------------------------
                   MARCH 31,   JUNE 30,  SEPT. 30,  DEC. 31,
                     1997       1997       1997       1997
                    ------     ------     ------     ------
<S>                <C>         <C>       <C>        <C>
Preclinical         $6,720      6,708      6,476      7,355
Clinical             2,909      3,277      3,972      4,085
Licensing/Other        276        160        175        184
                    ------     ------     ------     ------
Total                9,905     10,145     10,623     11,624
                    ======     ======     ======     ======

International        6,779      6,661      6,168      7,170
North America        2,850      3,324      4,280      4,270
Licensing/Other        276        160        175        184
                    ------     ------     ------     ------
Total               $9,905     10,145     10,623     11,624
                    ======     ======     ======     ======
</TABLE>


                                       29
<PAGE>   30
LIQUIDITY AND CAPITAL REQUIREMENTS

         Cash Reserves. The Company finances its operations and activities by
relying on (i) its operating activities for its working capital requirements,
(ii) its cash reserves, and (iii) its available lines of credit. Additionally,
the Company obtained a five year $5.0 million term loan from a large commercial
bank in the third quarter of 1997. As of December 31, 1997, the Company had cash
reserves (consisting of cash and cash equivalents and restricted cash) of
$7,385,000. The Company invests its excess cash in a diversified portfolio of
high-grade money market funds, United States Government-backed securities and
commercial paper and corporate obligations. The Company's cash reserves
(including its short-term investments and marketable securities) decreased by
approximately $11,095,000 during the year ended December 31, 1997 primarily due
to the following: (i) the payment of approximately $5,000,000 of outstanding
debt associated with the Acquisition of the clinical business; (ii) the payment
of approximately $1,380,000 of nonrecurring business combination costs
associated with the Acquisition of the clinical business; (iii) capital
expenditures of approximately $3,281,000, and (iv) the funding of operating
losses of approximately $2,639,000.

         Capital Expenditures. In 1997 the Company invested a total of
approximately $3,281,000 in property and equipment, as compared to approximately
$1,815,000 for fiscal 1996. This increase was primarily associated with
solidifying and expanding its position in preclinical continuous infusion
capabilities, updating and expanding information systems and supporting the
growth of the transgenic/gene targeting services business.

         Debt. In connection with the Acquisition on December 18, 1996, the
Company acquired approximately $9.8 million of short-term borrowings outstanding
under line of credit arrangements with various banks. The majority of such
borrowings and credit arrangements were guaranteed by certain prior stockholders
of the clinical business. One of the conditions of the closing of the
Acquisition was the release of these guarantees. In order to satisfy this
condition, on December 18, 1996, the Company paid approximately $4.0 million to
reduce these short-term borrowings and transferred approximately $4.6 million
into escrow for purposes of securing the future payment of the remaining
personally guaranteed borrowings. In January 1997, the Company paid the
remaining outstanding balance on these lines utilizing the cash in escrow and
established a new $3.0 million line of credit with a Swiss bank. As of December
31, 1997 the outstanding balance under this line of credit was approximately
$2,377,000.

         Additionally, the Company has lines of credit and overdraft privileges
with French banks in the aggregate amount of 10.5 million French Francs ($1.7
million at the exchange rate in effect on December 31, 1997). At December 31,
1997 and 1996 there were no short-term borrowings outstanding under these
facilities

         On March 16, 1998, the Company issued, in exchange for $5,000,000 cash,
a subordinated debenture and a warrant to purchase 2,000,000 shares of Common
Stock for $2.50 per share, to a wholly-owned subsidiary of MDS. The terms of the
subordinated debenture provide for semi-annual interest payments with the
aggregate principal amount payable on March 16, 2001. This debenture is
subordinate to certain outstanding indebtedness of the Company, including its
existing bank debt and mortgages described below. In addition, a portion or all
of the principal amount of the debenture may, at the option of the holder, be
satisfied by issuance of the shares of Common Stock in accordance with the terms
of the warrant.


                                       30
<PAGE>   31
         In December 1992, the Company acquired preclinical operations in
France. Included in the purchase price were promissory notes having an aggregate
principal amount of $7.0 million (the "Notes"). The unpaid principal balance on
the Notes as of December 31, 1996 of $5.0 million was paid-off in August 1997.
In the third quarter, the Company refinanced this debt by obtaining a five year
$5.0 million term loan from a large commercial bank, with the principal payable
in quarterly installments beginning September 1998. Interest will be paid
monthly over the life of the loan. This loan is secured by substantially all of
the Company's domestic assets, including the capital stock of its subsidiaries.
The Company was in default at December 31, 1997 under certain financial
covenants set forth in the credit agreement with respect to this term loan. In
the first quarter of 1998, the Company obtained a waiver of such default from
the commercial bank which provided this term loan.

         In connection with its U.S. preclinical facility, in 1994 the Company
secured (i) a $1.5 million 15-year mortgage with a bank and (ii) a $1.2 million
15-year mortgage from a Pennsylvania agency, which required cash collateral of
$450,000. These two loans are also secured by mortgages on the property
acquired. As of December 31, 1997, the aggregate outstanding balance under these
mortgages was approximately $2.3 million. The cash collateral on the mortgage
loan with the Pennsylvania agency is classified as restricted cash as of
December 31, 1997. Upon achievement of certain financial covenants, this
$450,000 of cash collateral will be released. Additionally, the favorable
interest rate on the mortgage with the Pennsylvania agency is subject to change
upon review by the agency of certain future conditions.

         Capital Requirements. The Company anticipates that its future capital
requirements may include investment for expansion of its operating
infrastructure to meet anticipated increased demand for drug development
services from the pharmaceutical and biotechnology industries. In connection
with the refinancing of the Notes (see " -- Debt"), the Company has quarterly
cash requirements for the repayment of principal beginning September 1998, and
monthly cash requirements for interest payments due throughout the five year
term of the loan, as well as a requirement to comply with certain restrictive
debt covenants. In addition, the Company will have semi-annual cash requirements
beginning in 1998 for the payment of interest on the subordinated debenture
issued in the MDS transaction. The Company believes that with its current
financial resources it has the ability to meet its working capital requirements
for the foreseeable future.

         The Company may, from time to time, consider funding its future capital
requirements including retirement of or interest payments on current debt by
issuing stock or other securities in public or private equity or debt
financings. In the event that the Company seeks to issue stock or other
securities, there can be no assurance that the Company will be able to issue
such stock or other securities or that any financing will be available to the
Company or that such offering or financing will be available on acceptable
terms.

         In addition to the above, the Company's working capital and other
capital requirements will depend on numerous factors, including among others:
success in increasing the Company's revenues and managing its operations;
maintaining its contractual relationship with its top customer; exchange rate
fluctuations between the U.S. dollar and foreign currencies; capital
expenditures for clinical and preclinical information system objectives; the
level of Company resources devoted to management, marketing, information and
data management capabilities and business and financial administration;
technological advances; and the status of competitors; as well as the costs of
potential future acquisitions, dispositions or strategic alliances described
below.


                                       31
<PAGE>   32
         Additionally, the Company from time to time may engage in discussions
regarding acquisitions, dispositions or strategic alliances. The Company may
finance such an acquisition or alliance with its existing cash resources or by
additional public or private debt or equity financings. In the event that the
Company seeks to pursue any such acquisition or alliance requiring financing,
there can be no assurance that any financing will be available to the Company or
that such financing will be available on acceptable terms. Although the Company
continually considers and evaluates potential acquisitions, dispositions or
alliances and related opportunities for growth, it does not have any
understandings, arrangements or agreements with respect to any such
acquisitions, dispositions or alliances.

EXCHANGE RATE FLUCTUATIONS

         Approximately 63%, 68% and 63% of the Company's net revenues for 1997,
1996 and 1995, respectively, were derived from the Company's operations outside
the United States. The Company's consolidated financial statements are
denominated in U.S. dollars and, accordingly, changes in exchange rates between
the applicable foreign currency and the U.S. dollar will affect the translation
of such subsidiary's financial results into U.S. dollars for purposes of
reporting the Company's consolidated financial results. Translation adjustments
are reported as a separate section of stockholders' equity.

         The Company may be subject to foreign currency transaction risks when
the Company's multi-country contracts are denominated in a currency other than
the currency in which the Company incurs the expenses related to such contracts.
For such multi-country contracts, the Company seeks to require its client to
incur the effect of fluctuations in the relative values of the contract currency
and the currency in which the expenses are incurred. To the extent the Company
is unable to require its clients to incur the effects of currency fluctuations,
these fluctuations could have a material effect on the results of operations of
the Company. The Company generally does not hedge its currency translation and
transaction exposure.

         Due to its preclinical operations in France, the percentage of the
Company's total revenues recorded in French Francs is significant. For the
fiscal years 1997, 1996 and 1995, the French operations accounted for
approximately 44%, 48% and 44% of the Company's revenues, respectively.
Accordingly, changes in the exchange rate between the French Franc and the U.S.
dollar will affect the translation of the French preclinical operation's
revenues and operating results into U.S. dollars for purposes of reporting the
Company's consolidated financial results, and also affect the U.S. dollar
amounts actually received by the Company from the French preclinical operations.
Based on the assumption that the French preclinical operations will continue to
represent a significant portion of the business of the Company, the appreciation
of the U.S. dollar against the French Franc would have an unfavorable impact on
the Company's revenues and a favorable impact on the Company's operating
expenses due to the effect of such currency translation on the French
preclinical operation's operating results; however, the depreciation of the U.S.
dollar against the French Franc would have a favorable impact on the Company's
revenues and an unfavorable impact on the Company's operating expenses. The net
effect of such impact can not be predicted with certainty.


                                       32
<PAGE>   33
         For purposes of the Company's consolidated financial results, the
results of operations of the French preclinical business denominated in French
Francs have been translated from French Francs into U.S. dollars using the
following exchange rates:

<TABLE>
<CAPTION>
                                    FRENCH FRANC       U.S. DOLLAR PER
                  PERIOD           PER U.S. DOLLAR       FRENCH FRANC
                  ------           ---------------     ---------------
                  <S>              <C>                 <C>
                   1997                5.8364               .1713
                   1996                5.1187               .1954
                   1995                4.9850               .2006
</TABLE>

The rates in the above table represent an average exchange rate calculated using
rates quoted in The Wall Street Journal. As of March 9, 1998, the French Franc
per U.S. dollar rate was 6.1235.

ACCUMULATED DEFICIT

         Since its inception in 1988 until the formation in 1994 and subsequent
sale of its partnership interest in Nextran in 1995, the Company expended
substantial funds for research and development and capital expenditures. A
significant portion of such expenditures were made to support the Company's
organ transplantation and blood substitute research and development programs,
which programs were transferred to the Nextran partnership. Historically, these
expenditures accounted for a substantial portion of the Company's accumulated
deficit. Also contributing to the accumulated deficit are the costs associated
with the development of a worldwide clinical business.

INFLATION

         The Company believes that inflation has not had a material impact on
its results of operations.

YEAR 2000

         The Company is currently taking steps to assess the Year 2000 issue
from an internal, supplier and customer perspective. Although the Company
believes at this time that neither the costs nor expenses of the Year 2000 issue
will be material to the Company, the ultimate costs and expenses are currently
unknown and such costs or the consequences of failure to correct any Year 2000
issues could have a material impact on Chrysalis' financial conditions, business
or operations.

FORWARD LOOKING STATEMENTS

         The statements contained in "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and elsewhere throughout this
Annual Report on Form 10-K that are not historical facts are "forward-looking
statements" within the meaning of Section 27A of the Securities Act of 1933 and
Section 21E of the Securities Exchange of 1934. These forward-looking statements
are subject to certain risks and uncertainties described below, which could
cause actual results to differ materially from those reflected in the
forward-looking statements. These forward-looking statements reflect
management's analysis, judgment, belief or expectation


                                       33
<PAGE>   34
only as of the date hereof. The Company undertakes no obligation to publicly
revise these forward-looking statements to reflect events or circumstances that
arise after the date hereof or to publicly release the results of any revisions
to such forward-looking statements that may be made to reflect events or
circumstances after the date hereof. In addition to the disclosure contained
herein, readers should carefully review any disclosure of risks and
uncertainties contained in other documents the Company files or has filed from
time to time with the Securities and Exchange Commission pursuant to the
Securities Exchange Act of 1934.

         Factors that could cause actual results to differ materially from those
reflected in the forward looking statements include, without limitation: the
degree of the Company's success in obtaining new contracts; the scope and
duration of drug development trials; the loss or downsizing of, or delay in,
existing drug development trials; the lengthening of the lead time to convert
proposals into contracts and revenues; the Company's exposure to cost overruns
under fixed-price contacts; the Company's dependence on certain clients,
especially its largest client, and on the pharmaceutical and biotechnology
industries; adverse trends in the regulatory environment, including health care
reform measures; the Company's dependence on key management personnel;
competition and consolidation in the drug development services industry;
liability for negligence or errors and omissions arising out of drug development
trials; foreign exchange rate fluctuations; and the costs associated with
integrating future acquired businesses. In addition, the Company's quarterly
operating results will continue to be subject to variation as a result of
factors such as those discussed above in " -- Quarterly Results" as well as the
costs associated with integrating the clinical and preclinical businesses.

ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

         Not applicable.


ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

         The information required by this Item 8 is set forth at pages F-1
through F-22 of the Consolidated Financial Statements contained in Part IV
hereof.


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

         None.


                                                      PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

         Information with respect to Directors of the Company is set forth in
the Proxy Statement under the heading "Election of Directors," which information
is incorporated herein by reference. Information regarding the executive
officers of the Company is included as Item 4A of Part I of this Annual Report
on Form 10-K as permitted by Instruction 3 to Item 401(b) of Regulation S-K.


                                       34
<PAGE>   35
Information required by Item 405 of Regulation S-K is set forth in the Proxy
Statement under the heading "Section 16(a) Beneficial Ownership Reporting
Compliance," which information is incorporated herein by reference.


ITEM 11.  EXECUTIVE COMPENSATION

         Information with respect to executive compensation is set forth in the
Proxy Statement under the headings "Election of Directors -- Compensation
Committee Interlocks and Insider Participation," "Election of Directors --
Compensation of Directors" and "Election of Directors -- Compensation of
Executive Officers," which information is incorporated herein by reference
(except for the Report of the Compensation Committee on Executive Compensation
and the Comparative Stock Performance Graph).


ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

         Information with respect to security ownership of certain beneficial
owners and management is set forth in the Proxy Statement under the heading
"Election of Directors -- Security Ownership of Certain Beneficial Owners and
Management," which information is incorporated herein by reference.


ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         Information with respect to certain relationships and related
transactions is set forth in the Proxy Statement under the heading, "Election of
Directors -- Compensation Committee Interlocks and Insider Participation" and
"Election of Directors -- Certain Relationships and Related Transactions," which
information is incorporated herein by reference.

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

         (a)   (1) and (2) Financial Statement and Financial Statement Schedules

               The responses to Items 14(a) (1) and (2) are set forth beginning
at page F-1 of this Annual Report on Form 10-K.

               (3) Listing of Exhibits

               See the exhibit index beginning at page X-1 of this Annual Report
on Form 10-K.

         (b)   Reports on Form 8-K

               The Company did not file any Current Reports on Form 8-K during
the fourth quarter.


                                       35
<PAGE>   36
         (c)      Exhibits

                  The response to Item 14(c) is set forth beginning at page X-1
of this Annual Report on Form 10-K.

         (d)      Financial Statement Schedules

                  None.


                                       36
<PAGE>   37
                                   SIGNATURES

         Pursuant to the requirements of Section 13 of the Securities Exchange
Act of 1934, the Company has duly caused this Report to be signed on its behalf
by the undersigned, thereunto duly authorized.

                                 CHRYSALIS INTERNATIONAL CORPORATION


                              By:/s/ John G. Cooper
                                 ------------------------------
                                 John G. Cooper
                                 Senior Vice President, Chief Financial Officer,
                                 Treasurer and Secretary

                                 Date:  March 27, 1998


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

<TABLE>
<S>                           <C>                                             <C>
*Paul J. Schmitt              Chairman of the Board, President and            March 27, 1998
---------------------------   Chief Executive Officer (Principal
Paul J. Schmitt               Executive Officer), Director



/s/ John G. Cooper            Senior Vice President, Chief Financial          March 27, 1998
---------------------------   Officer, Treasurer and Secretary
John G. Cooper                (Principal Financial Officer and
                              Principal Accounting Officer)



*Jack Barbut                  Vice Chairman, President of Clinical            March 27, 1998
---------------------------   Services, Director
Jack Barbut


*J. Christian Jensen          President of International Services, Director   March 27, 1998
---------------------------
J. Christian Jensen

---------------------------   Director                                        March 27, 1998
Desmond H. O'Connell

*Photios T. Paulson           Director                                        March 27, 1998
---------------------------
Photios T. Paulson


*Barry T. Sherman             Director                                        March 27, 1998
---------------------------
Barry T. Sherman


*W. Leigh Thompson            Director                                        March 27, 1998
---------------------------
W. Leigh Thompson
</TABLE>

*John G. Cooper, by signing his name hereto, does hereby sign this Annual Report
on Form 10-K on behalf of each of the above named and designated officers and
Directors of the Company pursuant to a Power of Attorney executed by such
persons and filed with the Securities and Exchange Commission.

/s/ John G. Cooper                                                March 27, 1998
---------------------------------
John G. Cooper, Attorney-in-Fact


                                       37
<PAGE>   38
                           ANNUAL REPORT ON FORM 10-K

                      ITEM 8, ITEM 14(a) (1) AND ITEM 14(d)

                   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

                          LIST OF FINANCIAL STATEMENTS

                          YEAR ENDED DECEMBER 31, 1997

                       CHRYSALIS INTERNATIONAL CORPORATION

                               RARITAN, NEW JERSEY
<PAGE>   39
                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

              CHRYSALIS INTERNATIONAL CORPORATION AND SUBSIDIARIES


                                                                            Page
                                                                            ----

Independent Auditors' Report..............................................  F-3

Consolidated Balance Sheets - December 31, 1997 and 1996..................  F-4

Consolidated Statements of Operations -
  Years ended December 31, 1997, 1996 and 1995............................  F-5

Consolidated Statements of Stockholders' Equity -
  Years ended December 31, 1997, 1996 and 1995............................  F-6

Consolidated Statements of Cash Flows -
 Years ended December 31, 1997, 1996 and 1995.............................  F-7

Notes to Consolidated Financial Statements -
  December 31, 1997, 1996 and 1995 .......................................  F-8


                                       F-2
<PAGE>   40
                          INDEPENDENT AUDITORS' REPORT


The Board of Directors and Stockholders
Chrysalis International Corporation:


We have audited the accompanying consolidated balance sheets of Chrysalis
International Corporation and subsidiaries as of December 31, 1997 and 1996, and
the related consolidated statements of operations, stockholders' equity and cash
flows for each of the years in the three-year period ended December 31, 1997.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Chrysalis
International Corporation and subsidiaries as of December 31, 1997 and 1996, and
the results of their operations and their cash flows for each of the years in
the three-year period ended December 31, 1997, in conformity with generally
accepted accounting principles.



                                                           KPMG Peat Marwick LLP
Princeton, New Jersey
March 4, 1998
<PAGE>   41
              CHRYSALIS INTERNATIONAL CORPORATION AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS
                           DECEMBER 31, 1997 AND 1996
                (IN THOUSANDS EXCEPT SHARE AND PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
                                                                   1997        1996
                                                                 --------     -------
<S>                                                              <C>          <C>
                                     ASSETS
Current assets
    Cash and cash equivalents                                    $  6,925      10,455
    Cash in escrow  (note 9)                                           --       4,550
    Short-term investments and marketable securities (note 2)          --       2,619
    Trade accounts receivable, net (note 3)                         9,669      10,788
    Prepaid expenses and other current assets                       1,916       1,433
                                                                 --------     -------
         Total current assets                                      18,510      29,845

Property and equipment, net (notes 6 and 10)                       15,127      15,963
Marketable debt securities (note 2)                                    --         396
Intangible assets, net (note 8)                                       805         953
Other assets                                                          338         326
Restricted cash (note 10)                                             460         460
                                                                 --------     -------

                                                                 $ 35,240      47,943
                                                                 ========     =======

                      LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities
    Short-term borrowings (note 9)                                  2,377      10,939
    Note payable - related party (note 14)                            291         299
    Current portion of long-term debt (note 10)                       768         180
    Accounts payable                                                3,204       3,386
    Accrued expenses (note 4)                                       5,567       8,273
    Deferred revenue                                                3,524       5,842
                                                                 --------     -------
         Total current liabilities                                 15,731      28,919

Long-term debt, excluding current portion (note 10)                 6,561       2,376
Deferred income taxes (note 13)                                     1,646       2,053
Other liabilities                                                     633       1,054
                                                                 --------     -------
         Total liabilities                                         24,571      34,402
                                                                 --------     -------

Stockholders' equity (notes 11 and 12):
    Serial preferred stock, $.01 par value, 5,000,000
       shares authorized; no shares issued and outstanding             --          --
    Common stock, $.01 par value, 20,000,000 shares
       authorized; issued and outstanding 11,430,764 in
       1997 and 11,359,721 in 1996                                    114         113
    Additional paid-in capital                                     57,768      57,498
    Translation adjustment                                           (536)        462
    Employee stock purchase loans                                     (86)        (86)
    Accumulated deficit                                           (46,591)    (44,541)
    Net unrealized gain on marketable securities                       --          95
                                                                 --------     -------
       Total stockholders' equity                                  10,669      13,541
                                                                 --------     -------

Commitments and contingencies (notes 15 and 17)
                                                                 $ 35,240      47,943
                                                                 ========     =======
</TABLE>


See accompanying notes to consolidated financial statements.


                                       F-4
<PAGE>   42
              CHRYSALIS INTERNATIONAL CORPORATION AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                  YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
                     (IN THOUSANDS EXPECT PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
                                                  1997        1996        1995
                                                --------     -------     -------
<S>                                             <C>          <C>         <C>
Revenues:
  Service revenue                               $ 47,271      47,398      43,233
  Less:  Reimbursed costs                         (5,769)     (6,425)     (4,551)
                                                --------     -------     -------
     Net service revenue                          41,502      40,973      38,682

  License fees and other                             796         514         927
                                                --------     -------     -------
                                                  42,298      41,487      39,609
                                                --------     -------     -------

Operating expenses:
  Direct costs                                    29,217      27,313      27,691
  Research and development                           166         528       1,063
  General, administrative and marketing           12,416      10,942       9,631
  Depreciation and amortization                    2,699       2,780       2,907
  Business combination costs (note 5)                 --       3,649          --
                                                --------     -------     -------
                                                  44,498      45,212      41,292
                                                --------     -------     -------

        Loss from operations                      (2,200)     (3,725)     (1,683)
                                                --------     -------     -------

Other income (expense):
  Interest income                                    465       1,187         648
  Interest expense (notes 9 and 10)                 (769)     (1,445)     (1,515)
  Foreign currency gain (loss), net                   11         517        (292)
  Other (notes 15 and 17)                            683         483         524
                                                --------     -------     -------
                                                     390         742        (635)
                                                --------     -------     -------
  Loss before equity in net loss of Nextran,
    gain on sale of Nextran and income taxes      (1,810)     (2,983)     (2,318)

Equity in net loss of Nextran (note 7)                --          --       2,700

Gain on sale of Nextran, net of taxes of
  $200 (note 7)                                       --          --      17,266
                                                --------     -------     -------

         Income (loss) before income taxes        (1,810)     (2,983)     12,248

Income tax expense (benefit) (note 13)               240         477        (177)
                                                --------     -------     -------

         Net income (loss)                      $ (2,050)     (3,460)     12,425
                                                ========     =======     =======

Basic earnings (loss) per share                 $  (0.18)      (0.31)       1.12
                                                ========     =======     =======

Weighted average shares outstanding-Basic         11,396      11,307      11,143
                                                ========     =======     =======

Diluted earnings (loss) per share               $  (0.18)      (0.31)       1.06
                                                ========     =======     =======

Weighted average shares outstanding-Diluted       11,396      11,307      11,675
                                                ========     =======     =======
</TABLE>


See accompanying notes to consolidated financial statements.


                                       F-5
<PAGE>   43
              CHRYSALIS INTERNATIONAL CORPORATION AND SUBSIDIARIES
                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                  YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
                       (IN THOUSANDS EXCEPT SHARE AMOUNTS)

<TABLE>
<CAPTION>
                                                                                                             NET UNREALIZED
                                                                                                               GAIN (LOSS)
                                                                                        EMPLOYEE                    ON        TOTAL
                                                   ADDITIONAL                             STOCK                 MARKETABLE   STOCK-
                                           COMMON   PAID-IN    DEFERRED    TRANSLATION  PURCHASE   ACCUMULATED     DEBT     HOLDERS'
                                            STOCK   CAPITAL  COMPENSATION  ADJUSTMENT     LOAN       DEFICIT    SECURITIES   EQUITY
                                           ------  --------- ------------  ----------   --------   -----------  ----------   ------
<S>                                        <C>     <C>       <C>           <C>          <C>        <C>             <C>      <C>
Balance, December 31, 1994                   111    57,111       (104)          80        (99)      (53,506)        78       3,671
Issuance of 135,248 shares of common
  stock upon exercise of stock options
  (note 12)                                    1       124         --           --         --            --         --
                                                                                                                               125
Issuance of 14,563 shares of common
  stock pursuant  to 401(k) plan (note 16)    --        56         --           --         --            --         --
                                                                                                                                56
Amortization of deferred compensation
  (note 12)                                   --        --        104           --         --            --         --
                                                                                                                               104
Translation adjustment                        --        --         --          606         --            --         --         606
Cash received on employee stock
 purchase loan                                --        --         --           --          6            --         --           6
Decrease in net unrealized gain on
  marketable debt securities                  --        --         --           --         --            --         (1)         (1)
Net income                                    --        --         --           --         --        12,425         --      12,425
                                             ---    ------       ----         ----     ------       -------     ------     -------
Balance, December 31, 1995                   112    57,291         --          686        (93)      (41,081)        77      16,992
Issuance of 101,650 shares of common
  stock upon exercise of stock options
  and warrants (note 12)                       1       112         --           --         --            --         --         113
Issuance of 18,065 shares of common
  stock pursuant to 401(k) plan (note 16)     --        95         --           --         --            --         --
                                                                                                                                95
Translation adjustment                        --        --         --         (224)        --            --         --        (224)
Cash received on employee stock
 purchase loan                                --        --         --           --          7            --         --           7
Increase in net unrealized gain on
  marketable debt securities                  --        --         --           --         --            --         18          18
Net loss                                      --        --         --           --         --        (3,460)        --      (3,460)
                                             ---    ------       ----         ----     ------       -------     ------     -------
Balance, December 31, 1996                   113    57,498         --          462        (86)      (44,541)        95      13,541
Issuance of 26,006 shares of common
  stock upon exercise of stock options
  and warrants (note 12)                      --        82         --           --         --            --         --          82
Issuance of 45,037 shares of common
  stock pursuant to 401(k) plan (note 16)      1       188         --           --         --            --         --
                                                                                                                               189
Translation adjustment                        --        --         --         (998)        --            --         --        (998)
Decrease in net unrealized gain on
  marketable debt securities                  --        --         --           --         --           (95)       (95)
Net loss                                      --        --         --           --         --        (2,050)        --      (2,050)
                                                    ------       ----         ----     ------       -------     ------     -------
Balance, December 31, 1997                   114    57,768         --         (536)       (86)      (46,591)        --      10,669
                                             ===    ======       ====         ====     ======       =======     ======     =======
</TABLE>

See accompanying notes to consolidated financial statements.


                                      F-6
<PAGE>   44
              CHRYSALIS INTERNATIONAL CORPORATION AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                  YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                                    1997       1996       1995
                                                                                  --------    -------    -------
<S>                                                                               <C>         <C>        <C>
Cash flows from operating activities:
  Net income (loss)                                                               $ (2,050)    (3,460)    12,425
  Adjustments to reconcile net income (loss) to net cash
    provided by (used in) operating activities:
        Non-cash items:
         Depreciation and amortization                                               2,699      2,958      3,119
         Foreign currency transaction (gain) loss                                      (11)      (517)       292
         Deferred income tax benefit                                                  (306)       (37)      (535)
         Loss on disposal of property and equipment                                      4         12         43
         Amortization of premium on short and long-term investments                     --        195         54
         Non-cash charges                                                              188         96         56
         Equity in net loss of Nextran                                                  --         --      2,700
         Gain on sale of partnership interest in Nextran                                --         --    (17,266)
  Change in operating assets and liabilities:
         (Increase) decrease in accounts receivable, net                               207       (460)    (1,049)
         (Increase) decrease in prepaid expenses and other current assets             (461)       (22)       203
         Increase in other assets                                                      (68)      (179)      (126)
         Increase (decrease) in accounts payable                                        66        590     (1,659)
         Increase (decrease) in accrued expenses                                    (2,228)     2,271        621
         Increase (decrease) in deferred revenue                                    (1,847)        30         (9)
         Increase (decrease) in other liabilities                                     (212)       502         10
                                                                                  --------    -------    -------
                  Net cash provided by (used in) operating activities               (4,019)     1,979     (1,121)
                                                                                  --------    -------    -------

Cash flows from investing activities:
  Decrease in restricted cash                                                           --        317        947
  (Increase) decrease in cash in escrow                                              4,550     (4,550)        --
  Purchases of property and equipment                                               (3,281)    (1,815)    (1,160)
  Proceeds from disposal of property and equipment                                      --         73          6
  Purchases of intangible assets                                                       (22)       (31)       (18)
  Purchases of investments                                                              --     (5,409)    (2,055)
  Proceeds from maturities of investments                                            2,518      3,697      1,000
  Proceeds from sale of partnership interest in Nextran                                 --         --     18,000
                                                                                  --------    -------    -------
         Net cash provided by (used in) investing activities                         3,765     (7,718)    16,720
                                                                                  --------    -------    -------

Cash flows from financing activities:
  Proceeds from short-term borrowings                                                2,398        660      1,899
  Payments on short-term borrowings                                                 (5,401)    (5,130)      (944)
  Proceeds from borrowings of long-term debt                                         5,000         --         --
  Principal payments on long-term debt                                              (5,203)    (1,014)      (719)
  Proceeds from stock options exercised and warrants issued                             82        113        125
  Payments received on employee stock purchase loans                                    --          7          7
  Increase in note payable - related party                                              --         17         20
                                                                                  --------    -------    -------
         Net cash provided by (used in) financing activities                        (3,124)    (5,347)       388
                                                                                  --------    -------    -------

Effect of exchange rate changes on cash                                               (152)       373       (218)
                                                                                  --------    -------    -------

Increase (decrease) in cash and cash equivalents                                    (3,530)   (10,713)    15,769

Cash and cash equivalents, beginning of year                                        10,455     21,168      5,399
                                                                                  --------    -------    -------

Cash and cash equivalents, end of year                                            $  6,925     10,455     21,168
                                                                                  ========    =======    =======

Supplemental disclosure of cash flow information Cash paid during the year for:
     Interest                                                                     $    769      1,005      1,450
     Income taxes                                                                    1,093         57      1,035
                                                                                  --------    -------    -------
   Noncash investing and financing activities:
     Unrealized gain on marketable debt securities                                $     --         95         77
                                                                                  --------    -------    -------
</TABLE>


   In 1995, the Company entered into capital lease obligations for laboratory
equipment in the amount of $60.

See accompanying notes to consolidated financial statements.


                                      F-7
<PAGE>   45
              CHRYSALIS INTERNATIONAL CORPORATION AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                        DECEMBER 31, 1997, 1996 AND 1995


(1)  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization:

         Chrysalis International Corporation, a Delaware Corporation
incorporated in 1988, (the "Company" or "Chrysalis"), formerly DNX Corporation
("DNX"), is an international contract research organization ("CRO") providing a
broad portfolio of integrated drug development services primarily to the
pharmaceutical and biotechnology industries. This portfolio of drug development
services includes transgenic discovery research, preclinical development and
clinical capabilities that enable the Company to manage a comprehensive drug
development program or a client's specific requirements. The Company generates
substantially all of its revenues from its drug development services business
and services more than 250 clients in 26 countries.

         On December 18, 1996, the Company issued 2,632,600 shares of Common
Stock in connection with the acquisition (the "Acquisition") by the Company of
all of the outstanding capital stock of, or equity interests in, BioClin, Inc.,
a Delaware corporation, BioClin Europe AG, a Swiss corporation, BioClin GmbH, a
German corporation, Kilmer N.V., a Netherlands Antilles corporation, and BioClin
Institute of Clinical Pharmacology GmbH, a German corporation (collectively, the
"BioClin Group"). This transaction was recorded using the "pooling-of-interests"
method of accounting (note 5).

         Chrysalis is also the exclusive commercial licensee of a U.S. patent
covering Pronuclear DNA Microinjection technology, the process widely used in
the pharmaceutical and biotechnology industries to develop transgenic animals.
The Company utilizes this license for its drug development services and grants
sublicenses for the use of this technology. These sublicenses entitle the
Company to receive revenues consisting of fees and, in certain cases, royalties.

Principles of consolidation:

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

Revenue recognition:

         Revenues from services are generally recognized in accordance with the
terms of the contract and in the periods in which the related services have been
rendered and the related costs incurred. Revenue related to contract
modifications is recognized after performance and when realization is assured
and the amounts are reasonably determinable. Adjustments to contract cost
estimates are made in the period in which the facts which require the revisions
become known. When the revised estimate indicates a loss, such loss is provided
for in its entirety. Revenues earned but not billed as of a given date are
reflected in the accompanying consolidated balance sheets as trade accounts
receivable (note 3). Funds received that relate to future performance under
service contracts are deferred and recognized as revenue when earned.

         Revenue from other contracts, primarily cost plus fixed-fee government
contracts, is recognized in the period in which the related services have been
rendered and costs incurred.

         Revenue from license fees is recognized upon issuance or renewal of
technology licenses. Additionally, sublicenses of the Company's proprietary DNA
Microinjection technology entitle the Company to receive additional revenues
consisting of royalties and milestone payments, which amounts are recognized as
revenue when received. To date, no material revenues have been received from
royalties and milestone payments.

Reimbursed costs:

         Substantially all amounts recorded as reimbursed costs in the
accompanying statements of operations relate to independent investigator and
travel costs. These costs are reimbursed by sponsors of the respective studies
in accordance with the respective contract terms. Payments received from
sponsors for investigator and travel costs in excess of costs incurred are
classified as deferred revenue and costs incurred in excess of amounts paid by
sponsors are classified as trade accounts receivable--unbilled.


                                      F-8
<PAGE>   46
              CHRYSALIS INTERNATIONAL CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)



(1)  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED

Cash and cash equivalents and short-term investments:

         The Company considers all highly liquid investments with an original
maturity of three months or less to be cash equivalents. Cash equivalents
consist primarily of money market funds, corporate obligations and U.S.
Government obligations and are carried at cost, which approximates market value.
Short-term investments consist primarily of U.S. Government and corporate
obligations which mature in one year or less. The Company has both the intent
and ability to hold its investments until maturity, and accordingly, all
investments are carried at amortized cost.

         The Company classifies its marketable debt securities into one or more
of the following categories: held-to-maturity, trading or available-for-sale.
All of the Company's marketable debt securities are foreign corporate debt
securities and are classified as available-for-sale. Available-for-sale
securities are recorded at fair market value and any unrealized gains or losses
are recorded as part of stockholders' equity.

Concentration of credit risks:

         The Company invests its excess cash in deposits with major financial
institutions, money market funds and notes issued by companies with strong
credit ratings. The Company has established guidelines relating to
diversification and maturities that maintain safety and liquidity. To date, the
Company has not experienced any losses on its cash equivalents and short-term
investments.

         The Company extends unsecured trade credit in connection with its
commercial services to a diversified customer base comprised of both foreign and
domestic entities, most of which are concentrated in the pharmaceutical and
biotechnology industries.

Property and equipment:

         Major additions and replacements of assets are capitalized at cost.
Maintenance, repairs and minor replacements are expensed as incurred. Property
and equipment are depreciated using the straight-line method over the following
periods: buildings and improvements--twenty to forty years; laboratory
equipment, vehicles, office and computer equipment, furniture and
software--three to ten years. Leasehold improvements are amortized using the
straight-line method over the estimated useful life of the asset or the lease
term, whichever is shorter. Upon retirement or sale, the cost of the assets
disposed of and the related accumulated depreciation are removed from the
accounts and any resulting gain or loss is credited or charged to operations.
Equipment leased under capital leases is capitalized with corresponding payment
obligations recorded in current and long-term debt.

Intangible assets:

         Costs in excess of net assets acquired are capitalized and are being
amortized on a straight-line basis over twenty years.

         Costs incurred in filing for patents are capitalized. Capitalized costs
related to unsuccessful patent applications are expensed when it becomes
determinable that such applications will be rejected. Capitalized costs related
to successful patent applications are amortized on a straight-line basis over a
period not to exceed seventeen years or the remaining life of the patent,
whichever is shorter.


                                      F-9
<PAGE>   47
              CHRYSALIS INTERNATIONAL CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(1)  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED

Income taxes:

         The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes"
(FAS 109). Under the asset and liability method of FAS 109, deferred tax assets
and liabilities are recognized for the estimated future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases. Deferred tax
assets and liabilities are measured using enacted tax rates in effect for the
year in which those temporary differences are expected to be recovered or
settled. Valuation allowances are established to reduce deferred tax assets if
it is determined to be "more likely than not" that all or some portion of the
potential deferred tax assets will not be realized. Under FAS 109, the effect on
deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date of the tax rate change.

Earnings (loss) per share:

         SFAS No. 128, "Earnings Per Share" (SFAS 128), was adopted by the
Company on December 31, 1997. In accordance with the pronouncement, all prior
year earnings per share data have been restated upon adoption to conform to the
new standards. SFAS 128 simplifies the calculation of earnings per share data by
replacing primary and fully diluted earnings per share with basic and diluted
earnings per share, respectively. Basic earnings per share excludes potentially
dilutive securities, including stock options, and is calculated by dividing net
income (loss) available to common stockholders by the weighted average common
shares outstanding for the period. Diluted earnings per share, which is
generally consistent with the fully diluted calculation under present accounting
rules, reflects the dilution to earnings that would occur if convertible
securities, stock options and potentially dilutive securities were converted
into common stock resulting in the issuance of common stock. Accordingly, all
prior period EPS data has been restated.

         In computing diluted earnings per share for the years ended December
31, 1997 and 1996, the denominator did not change from the computation of basic
earnings per share, because the effect of including potential common shares in
this calculation, would be antidilutive. If the effect on diluted earnings per
share had not been antidilutive, the denominator would have increased by 339,000
and 561,000 shares for 1997 and 1996, respectively. This increase in shares
represents the inclusion of stock options and warrants outstanding at December
31, 1997 and 1996 with an exercise price less then the average market price of
Chrysalis' common stock during 1997 and 1996, respectively. In computing diluted
earnings per share for the year ended December 31, 1995, the denominator was
increased by 532,000, representing the dilution of stock options and warrants
outstanding at December 31, 1995 with an exercise price less than the average
market price for the Company's stock during 1995.

Foreign currency translation:

         The financial statements of the Company's European subsidiaries are
translated into U.S. dollars in accordance with SFAS No. 52, "Foreign Currency
Translation." Substantially all assets and liabilities are translated at
year-end exchange rates and income and expense items are translated at an
average exchange rate. Exchange adjustments resulting from foreign currency
transactions are generally recognized in operations, whereas adjustments
resulting from the translation of financial statements are reflected as a
separate component of stockholders' equity.

Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of:

         Long-lived assets and certain identifiable intangibles are reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of assets to
be held and used is measured by a comparison of the carrying amount of an asset
to future net cash flows expected to be generated by the asset. If such assets
are considered to be impaired, the impairment to be recognized is measured by
the amount by which the carrying amount of the assets exceed the fair value of
the assets. Assets to be disposed of are reported at the lower of the carrying
amount or fair value less costs to sell.


                                      F-10
<PAGE>   48
              CHRYSALIS INTERNATIONAL CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED

Stock Option Plans:

         Prior to January 1, 1996, the Company accounted for its stock option
plans in accordance with the provisions of Accounting Principles Board ("APB")
Opinion No. 25, "Accounting for Stock Issued to Employees," and related
interpretations. As such, compensation expense would be recorded on the date of
grant only if the current market price of the underlying stock exceeded the
exercise price. On January 1, 1996, the Company adopted SFAS No. 123,
"Accounting for Stock-Based Compensation," which permits entities to recognize
as expense over the vesting period the fair value of all stock-based awards on
the date of grant. Alternatively, SFAS No. 123 also allows entities to continue
to apply the provisions of APB Opinion No. 25 and provide pro forma net income
and pro forma earnings per share disclosures for employee stock option grants
made in 1995 and future years as if the fair-value-based method defined in SFAS
No. 123 had been applied. The Company has elected to continue to apply the
provisions of APB Opinion No. 25 and provide the pro forma disclosure provisions
of SFAS No. 123 (note 12).

Use of estimates:

         The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.

Reclassification:
         Certain amounts contained in the 1996 and 1995 consolidated financial
statements have been reclassified to conform to the 1997 presentation.

New Accounting Pronoucements:

         The FASB has recently issued two new accounting standards, Statement
No. 130 "Reporting Comprehensive Income" and Statement No. 131, "Disclosure
about Segments of an Enterprise and Related Information," and if adopted will be
effective for periods presented after December 31, 1997. The Company is
evaluating the effect of these new statements.


(2)  SHORT-TERM INVESTMENTS AND MARKETABLE DEBT SECURITIES

         Short-term investments at December 31, 1996 were $2,518,000.

         Marketable debt securities outstanding at December 31, 1996 are
available for sale and are recorded in the accompanying consolidated balance
sheets at fair value. The amortized cost, gross unrealized holding gains and
fair value of available-for-sale foreign corporate debt securities as of
December 31, 1996 were $402,000, $95,000 and $497,000, respectively.

         Maturities of corporate debt securities classified as
available-for-sale as of December 31, 1996 were as follows:

<TABLE>
<CAPTION>
                                      AMORTIZED          FAIR
                                        COST             VALUE
                                        ----             -----
                                            (IN THOUSANDS)
<S>                                   <C>                <C>
Due within one year                     $ 79              101
Due after one year through five years    323              396
                                        ----              ---
                                        $402              497
                                        ====              ===
</TABLE>


                                      F-11
<PAGE>   49
              CHRYSALIS INTERNATIONAL CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


(3)  TRADE ACCOUNTS RECEIVABLE

         Trade accounts receivable as of December 31, 1997 and 1996 consist of
the following:

<TABLE>
<CAPTION>
                                         1997      1996
                                        -------   ------
                                         (IN THOUSANDS)
<S>                                     <C>        <C>
Trade accounts receivable--billed       $ 6,500    7,217
Trade accounts receivable--unbilled       3,310    3,701
                                        -------   ------
                                          9,810   10,918
Less: allowance for doubtful accounts       141      130
                                        -------   ------
                                        $ 9,669   10,788
                                        =======   ======
</TABLE>

         Trade accounts receivable--unbilled relates to revenues earned on
commercial services when the related services have been rendered and costs
incurred, but which were not billed to the customer as of the end of the
reporting period. At December 31, 1997 and 1996, there were no prerequisites for
billing such unbilled trade accounts receivable.

(4)  SUPPLEMENTAL BALANCE SHEET INFORMATION

         Accrued expenses as of December 31, 1997 and 1996 consist of the
following:

<TABLE>
<CAPTION>
                                              1997            1996
                                             ------          -----
                                                 (IN THOUSANDS)
<S>                                          <C>               <C>
Facilities costs                             $   --            155
Payroll and fringe benefits                   2,735          2,737
Professional fees                               120            245
Value-added taxes                               605            688
Income taxes                                    151            550
Interest                                         44            104
Investigator payment and contract expenses      575          1,532
Business combination costs                       44          1,380
Other                                         1,293            882
                                             ------          -----
                                             $5,567          8,273
                                             ======          =====
</TABLE>

(5)  MERGER WITH THE BIOCLIN GROUP

         On December 18, 1996, the Company issued approximately 2.6 million
shares of its common stock in exchange for all of the outstanding common stock
of the BioClin Group. The merger was accounted for as a pooling-of-interests and
accordingly, the Company's consolidated financial statements were restated to
include the accounts and operations of the BioClin Group for all periods prior
to the merger. Separate net revenue, net income (loss) and related earnings
(loss) per share amounts of the merged entities are presented in the following
table. In addition, the table includes unaudited pro forma net income (loss) and
earnings (loss) per share amounts which reflect the elimination of the
nonrecurring business combination costs in 1996.

<TABLE>
<CAPTION>
                                              1996         1995
                                            --------      -------
                                     (IN THOUSANDS, EXCEPT PER SHARE DATA)
                                                 (UNAUDITED)
<S>                                         <C>            <C>
Net revenue
         DNX                                $ 29,604       25,323
         BioClin Group                        11,883       14,286
                                            --------      -------
          Total                             $ 41,487       39,609
                                            ========      =======

Net income (loss)
         DNX                                $    474       12,566
         BioClin Group                          (285)        (141)
                                            --------      -------
         Proforma net income (loss)              189       12,425
         Merger costs                         (3,649)          --
                                            --------      -------
         Net income (loss), as reported     $ (3,460)      12,425
                                            ========      =======
</TABLE>


                                      F-12
<PAGE>   50
              CHRYSALIS INTERNATIONAL CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(5)  MERGER WITH THE BIOCLIN GROUP, CONTINUED

<TABLE>
<CAPTION>
                                        1996         1995
                                        ----         ----
<S>                                   <C>            <C>
Diluted Earnings (loss) per share
         As reported                  $  (0.31)      1.06
         Pro forma                        0.02       1.06
</TABLE>

         In connection with the merger, $3.6 million of business combination
costs and related expenses were incurred and expensed in the fourth quarter of
1996. The business combination costs and expenses primarily consisted of legal,
accounting, and investment banking fees, expenses related to creating and
promoting the new company name and other related expenses.


(6)  PROPERTY AND EQUIPMENT

         A summary of property and equipment as of December 31, 1997 and 1996 is
as follows:

<TABLE>
<CAPTION>
                                                           1997        1996
                                                           ----        ----
                                                            (IN THOUSANDS)
<S>                                                       <C>         <C>
Land                                                      $   501        537
Buildings and improvements                                 11,620     12,492
Leasehold improvements                                        837        408
Laboratory equipment                                        7,497      7,683
Office and computer equipment, software and furniture       6,379      4,876
                                                          -------     ------
                                                           26,834     25,996
Less accumulated depreciation and amortization             11,707     10,033
                                                          -------     ------
                                                          $15,127     15,963
                                                          =======     ======
</TABLE>

(7)  NEXTRAN

         On August 29, 1994, the Company, through a wholly-owned subsidiary,
entered into a Joint Venture Agreement (the Joint Venture Agreement) with Baxter
Transplant Holdings, Inc. (Holdings), a wholly-owned subsidiary of Baxter
Healthcare Corporation (Baxter), which is a subsidiary of Baxter International,
Inc. Under the Joint Venture Agreement, the Company and Holdings formed Nextran,
a Delaware general partnership, in which the Company had a 30% partnership
interest and Holdings had a 70% partnership interest. Pursuant to the terms of
the Purchase Agreement, dated September 22, 1995, as amended, the Company
consummated the sale of its 30% partnership interest in Nextran to Transplant
Acquisition Inc., a wholly owned subsidiary of Baxter, for a cash purchase price
of $18 million. Although the Company has sold its partnership interest in
Nextran, in the event that Nextran develops and commercializes hemoglobin blood
substitutes using technologies licensed to Nextran by the Company, the Company
will receive royalty income.

         Prior to the sale of its partnership interest in Nextran, the Company
recorded its share of Nextran's financial results of operations in its
consolidated financial statements according to the equity method of accounting.
As a result of the sale of its partnership interest in Nextran, the Company no
longer records a share of Nextran's financial results of operations in its
consolidated financial statements, subsequent to September 30, 1995.

(8)  INTANGIBLE ASSETS

         Intangible assets consist of the following components at December 31,
1997 and 1996:

<TABLE>
<CAPTION>
                                            1997       1996
                                            ----       ----
                                            (IN THOUSANDS)
<S>                                        <C>        <C>
Costs in excess of net assets acquired     $  983     1,139
Licensed technology                            61        61
Patent application costs                       91        69
                                           ------     -----
                                            1,135     1,269
Less accumulated amortization                 330       316
                                           ------     -----
                                           $  805       953
                                           ======     =====
</TABLE>


                                      F-13
<PAGE>   51
              CHRYSALIS INTERNATIONAL CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


(9)  SHORT-TERM BORROWINGS

         To support operations in France, the Company has lines of credit and
overdraft privileges with French banks in the aggregate amount of 10.5 million
French Francs ($1,700,000 at the exchange rates in effect on December 31, 1997).
At December 31, 1997 and 1996 there were no outstanding borrowings under these
credit facilities.

         The clinical business had line of credit arrangements with domestic and
foreign banks totaling approximately $6,410,000 as of December 31, 1996. The
amount outstanding under the line of credit arrangements amounted to
approximately $5,939,000 as of December 31, 1996. The majority of these
borrowings and credit arrangements were guaranteed by certain prior stockholders
of the clinical business. One of the conditions of the closing of the
Acquisition was the release of these guarantees. Therefore, in January 1997, the
Company paid off the outstanding balances on the majority of these line of
credit arrangements using the cash in escrow and established a new line of
credit arrangement with a Swiss bank totaling $3,000,000. This line is secured
by the clinical operation's trade accounts receivable and a guarantee by the
Company. The amount outstanding under this line of credit was approximately
$2,400,000 at December 31, 1997.

         At December 31, 1996, short-term borrowings included Promissory Notes
of $5,000,000, issued in connection with the acquisition of the French
preclinical business. In the third quarter of 1997, the Company refinanced this
debt by obtaining a five year $5,000,000 term loan (note 10).


(10)  LONG-TERM DEBT

         Long-term debt consists of the following components at December 31,
1997 and 1996:

<TABLE>
<CAPTION>
                                                                  1997       1996
                                                                  ----       ----
                                                                  (IN THOUSANDS)
<S>                                                              <C>        <C>
Term loan with a large commercial bank bearing interest
  at the prime rate plus 1.0% (9.5% as of December 31, 1997)
  with interest payable monthly, and principal payable in
  quarterly installments beginning September 1998                $5,000        --
Mortgage with a commercial bank, bearing interest
  at the prime rate plus 1.5% (10% as of December 31,
1997) due in monthly installments through 2009                    1,348     1,410
Mortgage with a Pennsylvania state agency, bearing
  interest at 2%, due in monthly installments
  through 2009                                                      975     1,048
Equipment line of credit                                             --        16
Equipment loan with Pennsylvania state agency                        --        55
Obligation under capital lease                                        6        27
                                                                 ------     -----
                                                                  7,329     2,556
Less: Current portion                                               768       180
                                                                 ------     -----
                                                                 $6,561     2,376
                                                                 ======     =====
</TABLE>

         Future principal maturities of long-term debt at December 31, 1997 are
as follows:

<TABLE>
<CAPTION>
                                               (IN THOUSANDS)
<S>                                            <C>
         1998                                        768
         1999                                      1,399
         2000                                      1,408
         2001                                      1,418
         2002                                        803
         Thereafter                                1,533
                                               ---------
                                               $   7,329
                                               =========
</TABLE>


                                      F-14
<PAGE>   52
              CHRYSALIS INTERNATIONAL CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


(10)  LONG-TERM DEBT, CONTINUED

         In December 1992, the Company acquired preclinical operations in
France. Included in the purchase price were promissory notes having an aggregate
principal amount of $7,000,000 (the "Notes"). The unpaid principal balance on
the Notes as of December 31, 1996 of $5,000,000 was paid-off in August 1997. In
the third quarter, the Company refinanced this debt by obtaining a five year
$5,000,000 term loan from a large commercial bank, with the principal payable in
quarterly installments beginning September 1998. Interest will be paid monthly
over the life of the loan. This loan is secured by substantially all of the
Company's domestic assets, including the capital stock of its subsidiaries. The
Company was in default at December 31, 1997 under certain financial covenants
set forth in the credit agreement with respect to this term loan. In the first
quarter of 1998, the Company obtained a waiver of such default from the
commercial bank which provided this term loan.

         In connection with its U.S. facility, the preclinical business secured
(i) a $1,500,000, 15-year mortgage with a bank, which originally required cash
collateral of $180,000, and (ii) a $1,200,000, 15-year mortgage from a
Pennsylvania agency, which required cash collateral of $450,000. These two loans
are also secured by mortgages on the property acquired. As a result of achieving
certain financial covenants, the cash collateral on the mortgage loan with the
bank was released in 1995. The cash collateral on the mortgage with the
Pennsylvania agency is classified as restricted cash as of December 31, 1997. If
the Company achieves certain financial milestones, this $450,000 of cash
collateral will be released. Additionally, the favorable interest rate on the
mortgage with the Pennsylvania agency is subject to change upon review by the
agency of certain future conditions.

         In May 1994, the preclinical business obtained a $500,000 equipment
loan from a Pennsylvania agency secured by certain of the equipment required in
connection with the expansion of the preclinical business' United States
operations. The unpaid principal balance on this loan was paid off in the third
quarter of 1997.


(11)  STOCKHOLDERS' EQUITY

 Warrants:

         In 1994, in conjunction with a financial consulting and advisory
arrangement, the Company issued a warrant to purchase 110,000 shares of Common
Stock exercisable at $4.25 per share to the advisor. The warrant is currently
exercisable and expires on December 31, 1998.


(12)  STOCK OPTION PLANS

         The Company maintains three stock incentive plans, the 1988 Stock Plan,
the 1991 Stock Option Plan and the 1996 Stock Option Plan, (the Plans), which
provide for the granting of options to officers, directors, employees and
consultants at an option price which approximates the fair market value of such
common shares at the date of grant as determined by the Board of Directors. The
Plans provide for an aggregate of 2,460,250 options to be granted. The options
are exercisable for a period of ten years after the date of grant and generally
vest over a four-year period. The weighted average exercise price of the options
granted under these plans was $3.91, $3.75 and $3.51 per share at December 31,
1997, 1996 and 1995, respectively.

         The weighted average fair values of stock options granted during 1997,
1996 and 1995 were $3.11, $2.77 and $1.97 per share respectively. Such fair
values are estimated on the date of grant using the Black-Scholes option-pricing
model with the following assumptions: in 1997, dividend yield of 0%; expected
volatility of 66%; risk-free interest rates of 6.25%; and expected lives of 7
years. In 1996 and 1995, the assumptions were: dividend yield of 0%; expected
volatility of 35%; risk-free interest rates of 7%; and expected lives of 7
years.


                                      F-15
<PAGE>   53
              CHRYSALIS INTERNATIONAL CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


(12)  STOCK OPTION PLANS, CONTINUED

         The Company applies APB Opinion No. 25 in accounting for its Plans. Had
the Company determined compensation cost based on the fair value at the grant
date for its stock options under SFAS No. 123, the Company's net income (loss)
would have been reduced to the pro forma amounts indicated below:

<TABLE>
<CAPTION>
                                1997         1996         1995
                                ----         ----         ----
                                        (IN THOUSANDS)
<S>                           <C>          <C>          <C>
         Net income (loss)
              As reported     $(2,050)     $(3,460)     $12,425
              Pro forma        (2,669)      (3,827)      12,282
</TABLE>

         The pro forma net income (loss) reflects only the options granted in
1997, 1996 and 1995. Therefore, the full impact of calculating compensation cost
for stock options under SFAS No. 123 is not reflected in the pro forma net
income (loss) amounts presented above because compensation cost is reflected
over the option's vesting period of four years and compensation cost for options
granted prior to January 1, 1995 is not considered.

         A summary of activity under the Plans for the years ending December 31,
1997, 1996 and 1995 are as follows:

<TABLE>
<CAPTION>
                                               COMMON STOCK OPTIONS
                                                    OUTSTANDING
                                                    -----------
                                            SHARES              PRICE PER SHARE
                                            ------              ---------------
<S>                                        <C>                 <C>
Balance, December 31, 1994                 1,292,343           $   0.40 - 10.50

  Granted                                    557,475              3.00  -  4.38
  Exercised                                 (135,248)             0.40   - 2.50
  Canceled                                  (111,176)             0.40   - 6.25
                                           ---------

Balance, December 31, 1995                 1,603,394               0.40 - 10.50

  Granted                                    473,150              4.44   - 7.25
  Exercised                                 (101,650)             0.40   - 6.00
  Canceled                                   (50,131)             2.50   - 6.50
                                           ---------

Balance, December 31, 1996                 1,924,763               0.40 - 10.50
                                           ---------

  Granted                                    123,000              3.44   - 5.50
  Exercised                                  (26,006)             0.50   - 4.75
  Canceled                                   (96,582)             2.50   - 6.00
                                           ----------

Balance, December 31, 1997                 1,925,175               0.40  -10.50
                                           =========

Shares exercisable at December 31, 1997    1,379,023
                                           =========
</TABLE>


                                      F-16
<PAGE>   54
              CHRYSALIS INTERNATIONAL CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


(13)  INCOME TAXES

         Income tax expense (benefit) attributable to the net income (loss)
consists of the following during the years ended December 31, 1997, 1996 and
1995:

<TABLE>
<CAPTION>
                      1997       1996      1995
                      ----       ----      ----
                            (IN THOUSANDS)
<S>                   <C>        <C>       <C>
Current
  U.S. Federal        $  --        --       232
  State and local        --        --        --
  Foreign               756       514       326
                      -----      ----      ----
                        756       514       558
                      -----      ----      ----
Deferred
  U.S. Federal           --        --        --
  State and local        --        --        --
  Foreign              (516)      (37)     (535)
                      -----      ----      ----
                       (516)      (37)     (535)
                      -----      ----      ----
                      $ 240       477        23
                      -----      ====      ----
</TABLE>

         Income tax expense (benefit) attributable to the net income (loss) for
the years ended December 31, 1997, 1996 and 1995 differed from the amounts
computed by applying the U.S. federal income tax rate of 34 percent to the
income (loss) before income tax expense (benefit) as a result of the following:

<TABLE>
<CAPTION>
                                                      1997        1996        1995
                                                      ----        ----        ----
                                                             (IN THOUSANDS)
<S>                                                  <C>        <C>          <C>
Computed "expected" income tax expense (benefit)     $(615)     (1,014)      4,263
Increase (reduction) in income taxes resulting
  from:
  Change in the beginning-of-the-year balance
    of the valuation allowance  for Federal
    deferred tax assets allocated to income
    tax expense                                        326         206      (3,831)
  Nondeductible reorganization expenses                 --       1,241          --
  Foreign tax rate differential                        499          82        (394)
  Changes in enacted tax rates                          30          --          --
  Alternative minimum taxes                             --          --          32
  Other, net                                            --         (38)        (47)
                                                     -----      ------      ------

                                                     $ 240         477          23
                                                     -----      ------      ------
</TABLE>


                                      F-17
<PAGE>   55
              CHRYSALIS INTERNATIONAL CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


(13)  INCOME TAXES, CONTINUED

         The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at December 31,
1997 and 1996 are presented below:

<TABLE>
<CAPTION>
                                                               1997          1996
                                                               ----          ----
                                                                (IN THOUSANDS)
<S>                                                          <C>            <C>
Deferred tax assets:
  Retirement indemnities                                     $    192          243
  Other                                                           139          119
  Deferred revenue                                                288          971
  Accrued expenses                                                223          625
  Capitalized research and development costs                      643          436
  Net operating loss carryforwards                             13,547       12,657
  Tax credit carryforward                                       3,179        3,167
                                                             --------      -------
         Total gross deferred tax assets                       18,211       18,218
  Less valuations allowance                                    17,803       17,477
                                                             --------      -------
         Net deferred tax assets                                  408          741
                                                             --------      -------

Deferred tax liabilities:
  Property and equipment, principally due to allocation
    of the purchase price of the French operation and
    differences in depreciation and capitalized interest       (1,259)      (1,980)
  Other                                                          (387)        (512)
                                                             --------      -------
         Total gross deferred liabilities                      (1,646)      (2,492)
                                                             --------      -------

         Net deferred tax liability                          $ (1,238)      (1,751)
                                                             ========      =======
</TABLE>

         The valuation allowance for deferred tax assets as of January 1, 1995
was $17,197,000. The net change in the total valuation allowance for the years
ended December 31, 1997, 1996 and 1995 were (decreases) increases of $326,000,
$280,000, and (3,424,000), respectively.

         At December 31, 1997, the Company has net operating loss carryforwards
for Federal income tax purposes of approximately $26,434,000 which are available
to offset future Federal taxable income, if any, through 2012.

         The Company also has research and development tax credit carryforwards
of approximately $3,012,000 for federal income tax reporting purposes which are
available to reduce federal income taxes, if any, through 2011. The Company has
alternative minimum tax credit carryforwards of approximately $164,000 for
federal income tax reporting purposes which are available to reduce federal
income taxes, if any. These tax credits have an unlimited carryforward period.


(14)  RELATED PARTY TRANSACTIONS

Note Payable - Related Party:

         As of December 31, 1997 and 1996, the Company owed approximately
$291,000 and $299,000, respectively, to a relative of an officer and major
shareholder. The note payable bears interest at a rate of 6.25% and is unsecured
and due upon demand. Amounts outstanding as of December 31, 1997 and 1996
include accrued interest of approximately $17,000 and $66,000, respectively.

Indemnification by certain stockholders:

         Pursuant to the Acquisition agreement, certain stockholders indemnify
the Company for certain named litigation costs. As a result of this
indemnification, the Company has established a receivable due from the
stockholders in the amount of $284,000 and $265,000 as of December 31, 1997 and
1996, respectively, payable in Common Stock at $5.0625 per share, the closing
price at December 18, 1996.


                                      F-18
<PAGE>   56
              CHRYSALIS INTERNATIONAL CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


(15)  COMMITMENTS AND CONTINGENCIES

         The Company leases office and laboratory facilities and equipment under
various noncancellable operating lease agreements. Future minimum rental
commitments for the next five years as of December 31, 1997 on the
aforementioned operating leases are as follows:

<TABLE>
<CAPTION>
                                                                    OPERATING
                                                                     LEASES
                                                                     ------
                                                                 (IN THOUSANDS)
<S>                                                              <C>
1998                                                                $ 1,509
1999                                                                  1,305
2000                                                                    821
2001                                                                    373
2002                                                                     86
Thereafter                                                                1
                                                                    -------
Total minimum lease payments                                        $ 4,095
                                                                    =======
</TABLE>

         Rental expense aggregated $1,493,000, $1,312,000, and $1,106,000 in
1997, 1996 and 1995, respectively.

         In 1994, the Company reversed into income $300,000 which was previously
an accrued liability, established in connection with the Company's curtailment
of the blood substitute program for the estimated restoration costs of its
Plainsboro pilot plant facility, when the Company was relieved of these
obligations upon a new tenant assuming the lease for this facility without
requiring restoration. In addition, in connection with this transaction, in
January 1995 the Company sold certain equipment associated with the pilot plant
to this new tenant for a total of $600,000 to be paid over 21 months.


(16)  EMPLOYEE BENEFITS

Pension Plans:

         The clinical business maintains a pension plan for its key management
employees in Europe, one of whom is also a major shareholder. The plan provides
benefits based upon age, years of service, and remuneration. The plan is an
unfunded book reserve plan. Expenses for this plan totaled approximately
$158,000, $104,000, and $172,000 for the years ended December 31, 1997, 1996 and
1995, respectively.

         Most retirement benefits in France are paid out under the auspices of a
government-sponsored defined contribution retirement plan. Under the terms of
labor agreements, however, employees are entitled to an additional lump sum
payment at retirement provided they are still employed by the preclinical French
operation at their normal retirement date.

         Net periodic pension cost for 1997, 1996 and 1995 includes the
following components:

<TABLE>
<CAPTION>
                                                    1997     1996   1995
                                                    ----     ----   ----
                                                       (IN THOUSANDS)
<S>                                                 <C>      <C>    <C>
Service costs-benefits earned during the period     $ 32      34     39
Interest cost on projected benefit obligation         26      25     27
Net amortization and deferral                        (18)     25     19
                                                    ----      --     --
         Net periodic pension cost                  $ 40      84     85
                                                    ====      ==     ==
</TABLE>


                                      F-19
<PAGE>   57
              CHRYSALIS INTERNATIONAL CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


(16)  EMPLOYEE BENEFITS, CONTINUED


         The present value of benefit obligations and the funded status of the
preclinical French operation's retirement indemnities recognized in the
Company's consolidated balance sheets as of December 31, 1997 and 1996 are as
follows:

<TABLE>
<CAPTION>
                                                   1997    1996
                                                   ----    ----
                                                  (IN THOUSANDS)
<S>                                                <C>     <C>
Actuarial present value of accumulated benefit
  obligations (no amounts are vested)              $418     454
Additional amounts related to salary increases       38      30
                                                   ----     ---
  Total projected benefit obligation                456     484
                                                   ----     ---
Plan assets at fair value                            --      --
  Accrued pension cost                             $456     484
                                                   ====     ===
</TABLE>

         Assumptions used in the actuarial computations for 1997, 1996 and 1995
are as follows:

<TABLE>
<CAPTION>
                                       1997        1996        1995
                                      ------      ------      ------
<S>                                   <C>         <C>         <C>
Discount rate                           8.0%        6.0%        6.0%
Rate of compensation increases          2.0%        2.0%        3.0%
</TABLE>

Profit-sharing of the operations in France:

         Profit-sharing is a requirement under French law. The payments are made
to employees after a period of 5 years unless certain conditions are met and
payment can be made earlier. During 1997, 1996 and 1995, profit sharing costs
aggregated $199,000, $181,000 and $0, respectively.

Savings Plan:

         The Company has an employee savings plan ("Savings Plan"), that
qualifies as a deferred salary arrangement under Section 401(k) of the Internal
Revenue Code. Under the Savings Plan, participating U.S. employees may defer a
portion of their pretax earnings, up to the Internal Revenue Service annual
contribution limit. Effective May 1, 1993, the Company amended the Savings Plan
to provide for a Company match of 50% of each employee's contributions with
newly issued common stock of the Company. For the years ended December 31, 1997,
1996 and 1995, the Company issued 45,037, 18,065 and 14,563 shares of common
stock, respectively, to participants in the Savings Plan. Charges to operations
for the years ended December 31, 1997, 1996 and 1995 aggregated $188,000,
$95,000 and $56,000, respectively, under this plan.


(17)  LEGAL PROCEEDINGS

         In the ordinary course of business, the Company is involved in certain
legal actions. In the opinion of management, based upon the advice of counsel,
the resolution of these legal matters will not have a material effect upon the
Company or its financial condition.

         In 1995, the Company terminated its relationship with the Virginia
Commonwealth University (VCU), which performed Phase I and analytical services
on behalf of the Company in the United States. The Company signed a settlement
agreement with VCU in the third quarter of 1997, that was significantly less
than the recorded liability. This action resulted in a book gain of $700,000,
which was recorded in other income in the third quarter of 1997.


                                      F-20
<PAGE>   58
              CHRYSALIS INTERNATIONAL CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


(18)  BUSINESS SEGMENT AND CUSTOMER INFORMATION

Business segment information:

         The Company operates in two geographic areas. Information on the
Company's geographic operations is set forth in the table below.

<TABLE>
<CAPTION>
                                         1997         1996          1995
                                         ----         ----          ----
                                                 (IN THOUSANDS)
<S>                                    <C>            <C>          <C>
Net revenues:
  North American operations            $ 15,520       13,165       14,719
  International operations               26,778       28,322       24,890
                                       --------      -------      -------
         Total net revenues            $ 42,298       41,487       39,609
                                       ========      =======      =======

Operating income (loss):
  North American operations            $   (838)        (381)        (294)
  International operations                 (255)       1,166         (493)
  General corporate                      (1,107)        (861)        (896)
  Special charge                             --       (3,649)          --
                                       --------      -------      -------
         Total operating loss          $ (2,200)      (3,725)      (1,683)
                                       ========      =======      =======

Identifiable assets:
  North American operations            $ 11,017        9,388       10,031
  International operations               19,839       24,129       24,616
  General corporate                       4,384       14,426       20,777
                                       --------      -------      -------
         Total identifiable assets     $ 35,240       47,943       55,424
                                       ========      =======      =======
</TABLE>

Customer information:

         For the year ended December 31, 1997 net revenues from one customer
aggregated approximately $9,537,000 or 23% of the Company's total net revenues.
For the year ended December 31, 1996 net revenues from one customer aggregated
approximately $5,021,000 or 12% of the Company's total net revenues. For the
year ended December 31, 1995, net revenues from one customer aggregated
approximately $6,408,000 or 16% of the Company's total net revenues.

         As described in note 17, in 1995 the Company terminated its
relationship with VCU, which performed Phase I and analytical services on behalf
of the Company in the United States. The combined statements of operations
include net revenues related to these services in the amount of $3,465,000 in
1995.


 (19)  DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS

Cash and cash equivalents, short-term investments, trade accounts receivable,
accrued interest receivable, restricted cash, accounts payable, and accrued
expenses:

         The carrying amount approximates fair value because of the short term
maturity of these instruments.

Long-term debt:

         The carrying amount of long-term debt with variable interest rates
approximates fair value due to its variable nature. The fair value of long-term
debt with fixed interest rates is estimated on the current rates offered to the
Company for debt of the same remaining maturities. The carrying amount of
long-term debt with fixed interest rates aggregated $975,000 and $1,103,000
while the fair value approximated $605,000 and $642,000 as of December 31, 1997
and 1996, respectively.


                                      F-21
<PAGE>   59
              CHRYSALIS INTERNATIONAL CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


(20)        SUBSEQUENT EVENT (UNAUDITED)

         On March 16, 1998, the Company issued, in exchange for $5,000,000 cash,
a subordinated debenture and a warrant to purchase 2,000,000 shares of Common
Stock for $2.50 per share to a wholly-owned subsidiary of MDS Inc. The terms of
the subordinated debenture provide for semi-annual interest payments with the
aggregate principal amount payable on March 16, 2001. The debenture is
subordinate to certain outstanding indebtedness of the Company, including its
existing bank debt and mortgages. In addition, a portion or all of the principal
amount of the debenture may, at the option of the holder, be satisfied by
issuance of the shares of Common Stock in accordance with the terms of the
warrant.


                                      F-22
<PAGE>   60
                                  EXHIBIT INDEX


(3)  Articles of Incorporation and Bylaws

         (i)      Third Amended and Restated Certificate of Incorporation of the
                  Company is incorporated herein by reference to Exhibit 3.1 to
                  the Company's Current Report on Form 8-K dated December 18,
                  1996.

         (ii)     Certificate of Amendment of Certificate of Incorporation of
                  the Company is incorporated by reference to Exhibit 3(ii) of
                  the Company's Annual Report on Form 10-K for the fiscal year
                  ended December 31, 1995.

         (iii)    Third Amended and Restated Bylaws of the Company is
                  incorporated herein by reference to Exhibit 3.2 to the
                  Company's Current Report on Form 8-K dated December 18, 1996.

(4) Instruments defining the Rights of Security Holders, including Indentures

         (i)      Stockholders' Agreement, dated as of December 18, 1996, among
                  DNX Corporation, Dr. Gerald Rittershaus, as Trustee and
                  Employee Trustee, Manfred Wissman, as Trustee, Dr. Jack
                  Barbut, Alec Hackel, Dr. John Christian Jensen, Sherby N.V.,
                  Martha Lee Reynolds, Barry Dvorchik, Bettina Donhardt and
                  Christine Dune-Kraatz is incorporated herein by reference to
                  Exhibit 2.4 to the Company's Current Report on Form 8-K dated
                  December 18, 1996.

(10)  Material Contracts

         (i)        *1988 Stock Plan of the Company, as amended, is incorporated
                    herein by reference to Exhibit 10(i) of the Company's Annual
                    Report on Form 10-K for the fiscal year ended December 31,
                    1995.

         (ii)       *1991 Stock Option Plan of the Company, as amended, is
                    incorporated herein by reference to Exhibit 10(ii) of the
                    Company's Annual Report on Form 10-K for the fiscal year
                    ended December 31, 1995.

         (iii)      *1996 Stock Option Plan of the Company is incorporated by
                    reference to Appendix G to the Company's Schedule 14A dated
                    November 8, 1996.

         (iv)       *Employment Agreement between Pharmakon Research
                    International, Inc. and Leif Modeweg, dated as of June 28,
                    1993, is incorporated herein by reference to Exhibit 10(iv)
                    of the Company's Annual Report on Form 10-K for the fiscal
                    year ended December 31, 1995.

         (v)        *Employment Agreement between the Company and John G.
                    Cooper, dated May 29, 1996, is incorporated herein by
                    reference to Exhibit 10(v) of the Company's Annual Report on
                    Form 10-K for the fiscal year ended December 31, 1996.

         (vi)       *Employment Agreement between the Company and Paul J.
                    Schmitt, dated June 2, 1995, is incorporated herein by
                    reference to Exhibit 10.1 of the Company's Quarterly Report
                    on Form 10-Q for the period ended June 30, 1995.

         (vii)      *Employment Agreement between the Company and John Christian
                    Jensen, dated December 18, 1996, is incorporated herein by
                    reference to Exhibit 10(vii) of the Company's Annual Report
                    on Form 10-K for the fiscal year ended


                                       X-1
<PAGE>   61
                    December 31, 1996.

         (viii)     *Employment Agreement between the Company and Dr. Jack
                    Barbut, dated December 18, 1996, is incorporated herein by
                    reference to Exhibit 10(viii) of the Company's Annual Report
                    on Form 10-K for the fiscal year ended December 31, 1996.

         (ix)       *Consulting Agreement between the Company and Dr. Jack
                    Barbut dated December 18, 1996, is incorporated herein by
                    reference to Exhibit 10(ix) of the Company's Annual Report
                    on Form 10-K for the fiscal year ended December 31, 1996.

         (x)        *Form of Individual Long Term Disability Policy of New
                    England Mutual Life Insurance Company for Corporate Officers
                    is incorporated herein by reference to Exhibit 10(vii) of
                    the Company's Annual Report on Form 10-K for the fiscal year
                    ended December 31, 1995.

         (xi)       Assignment Agreement between Genetic Engineering, Inc. and
                    the Company dated October 30, 1989, is incorporated herein
                    by reference to Exhibit 10(viii) of the Company's Annual
                    Report on Form 10-K for the fiscal year ended December 31,
                    1995.

         (xii)      License Agreement between Ohio University and DNX, Inc.
                    dated June 13, 1985, as amended July 1, 1991, is
                    incorporated herein by reference to Exhibit 10.6 to
                    Amendment No. 2 to the Company's Registration Statement on
                    Form S-1 filed December 10, 1991 (Registration Statement No.
                    33-43553). Certain confidential information contained in
                    such Exhibit 10.6 has been granted confidential treatment by
                    the Commission on December 10, 1991.

         (xiii)     Exclusive Worldwide License Agreement between Princeton
                    University and DNX, Inc. dated December 22, 1987, as amended
                    December 28, 1990, is incorporated herein by reference to
                    Exhibit 10.7 to Amendment No. 3 to the Company's
                    Registration Statement on Form S-1 filed December 10, 1991
                    (Registration Statement No. 33-43553). Certain confidential
                    information contained in such Exhibit 10.7 has been granted
                    confidential treatment by the Commission on December 10,
                    1991.

         (xiv)      License Agreement between The Board of Trustees of the
                    Leland Stanford Junior University and DNX, Inc. effective as
                    of July 1, 1990, is incorporated herein by reference to
                    Exhibit 10(x) to the Company's Annual Report on Form 10-K
                    for the fiscal year ended December 31, 1995.

         (xv)       Lease made as of August 28, 1991 between Richard J. Matthews
                    and Sally G. Matthews and Pharmakon is incorporated herein
                    by reference to Exhibit 10(xii) to the Company's Annual
                    Report on Form 10-K for the fiscal year December 31, 1995.

         (xvi)      *Form of Indemnification Agreement between the Company and
                    its officers and directors is incorporated herein by
                    reference to Exhibit 10(xiii) to the Company's Annual Report
                    on Form 10-K for the fiscal year ended December 31, 1995.

         (xvii)     Warrant Agreement to Purchase Shares of Common Stock of the
                    Company, as amended as of December 23, 1997, by and among
                    the Company and Hambrecht & Quist Incorporated.


                                      X-2
<PAGE>   62
         (xviii)    Agreement of Sale dated March 3, 1993 between Scranton
                    Lackawanna Industrial Building Company and Pharmakon is
                    incorporated herein by reference to Exhibit 10(xxxv) to the
                    Company's Annual Report on Form 10-K for the fiscal year
                    ended December 31, 1995.

         (xix)      Loan Agreement dated June 29, 1993 between First Eastern
                    Bank, N.A. and Pharmakon is incorporated herein by reference
                    to Exhibit 10(xxxvi) to the Company's Annual Report on Form
                    10-K for the fiscal year ended December 31, 1995.

         (xx)       Joint Venture Agreement, dated as of August 29, 1994 by and
                    among DNX Biotherapeutics and Baxter Transplant Holdings,
                    Inc. is incorporated herein by reference to Exhibit
                    10(xxxvii) to the Company's Annual Report on Form 10-K for
                    the fiscal year ended December 31, 1995.

         (xxi)      Asset Transfer Agreement, dated as of August 29, 1994 by and
                    among the Company, DNX Biotherapeutics, Baxter Healthcare
                    Corporation and Baxter Transplant Holdings, Inc is
                    incorporated herein by reference to Exhibit 10(xxxviii) to
                    the Company's Annual Report on Form 10-K for the fiscal year
                    ended December 31, 1995.

         (xxii)     Guaranty Agreement (DNX), dated as of August 29, 1994 by and
                    among the Company, Nextran, Baxter Transplant Holdings,
                    Inc., and Baxter Healthcare Corporation is incorporated
                    herein by reference to Exhibit 10(xxxix) to the Company's
                    Annual Report on Form 10-K for the fiscal year ended
                    December 31, 1995.

         (xxiii)    Assignment and Assumption of Lease, dated August 29, 1994 by
                    and among the Company, DNX Biotherapeutics, Inc. and Baxter
                    Transplant Holdings, Inc. is incorporated herein by
                    reference to Exhibit 10(xl) to the Company's Annual Report
                    on Form 10-K for the fiscal year ended December 31, 1995.

         (xxiv)     Agreement, dated October 8, 1996, between the Company and
                    Nextran.

         (xxv)      Intentionally omitted

         (xxvi)     Loan Agreement, dated as of October 3, 1994 by and between
                    Scranton Lackawanna Industrial Building Company and The
                    Pennsylvania Industrial Development Authority is
                    incorporated herein by reference to Exhibit 10(xliii) to the
                    Company's Annual Report on Form 10-K for the fiscal year
                    ended December 31, 1995.

         (xxvii)    Promissory Note in the principal amount of $1,200,000, dated
                    as of October 3, 1994, made by Scranton Lackawanna
                    Industrial Building Company to the order of The Pennsylvania
                    Industrial Development Authority is incorporated herein by
                    reference to Exhibit 10(xliv) to the Company's Annual Report
                    on Form 10-K for the fiscal year ended December 31, 1995.

         (xxviii)   Consent, Subordination and Assumption Agreement, effective
                    as of October 3, 1994 by Pharmakon and Scranton Lackawanna
                    Industrial Building Company in favor of The Pennsylvania
                    Industrial Development Authority is incorporated herein by
                    reference to Exhibit 10(xlv) to the Company's Annual Report
                    on Form 10-K for the fiscal year ended December 31, 1995.

         (xxix)     Loan Agreement, dated May 25, 1994 by and between Pharmakon
                    and the Commonwealth of Pennsylvania, acting by and through
                    the Department of


                                      X-3
<PAGE>   63
                    Commerce is incorporated herein by reference to Exhibit
                    10(xlvi) to the Company's Annual Report on Form 10-K for the
                    fiscal year ended December 31, 1995.

         (xxx)      Purchase Agreement, dated as of September 23, 1995, by and
                    among Transplant Acquisition Inc., Baxter HealthCare
                    Corporation, DNX Biotherapeutics, Inc. and DNX Corporation
                    is incorporated herein by reference to Exhibit 2.1 of the
                    Company's Current Report on Form 8-K filed on October 31,
                    1995.

         (xxxi)     Amendment No. 1 to Purchase Agreement, dated as of September
                    29, 1995, by and among Transplant Acquisition Inc., Baxter
                    HealthCare Corporation, DNX Biotherapeutics, Inc. and DNX
                    Corporation is incorporated herein by reference to Exhibit
                    2.2 of the Company's Current Report on Form 8-K filed on
                    October 31, 1995.

         (xxxii)    Merger Agreement, dated as of August 19, 1996, among DNX
                    Corporation, DNX Acquisition Corporation, Dr. Jack Barbut,
                    Alec Hackel, Dr. John Christian Jensen, Sherby N.V. and
                    BioClin, Inc. is incorporated herein by reference to Exhibit
                    2.1 to the Current Report on Form 8-K filed by the Company
                    on August 19, 1996.

         (xxxiii)   Share Exchange Agreement, dated as of August 19, 1996, among
                    DNX Corporation, Mr. Manfred Wissman, as Trustee, Dr. Gerald
                    Rittershaus, as Employee Trustee, Dr. Jack Barbut, Alec
                    Hackel, Dr. John Christian Jensen, Bettina Donhardt,
                    Christine Dune-Kraatz, BioClin GmbH, Kilmer N.V. and BioClin
                    Europe AG is incorporated herein by reference to Exhibit 2.2
                    to the Company's Current Report on Form 8-K filed on August
                    19, 1996.

         (xxxiv)    Share Acquisition Agreement, dated as of August 19, 1996,
                    among DNX Corporation, Dr. Gerald Rittershaus, as Trustee,
                    Dr. Jack Barbut, Alec Hackel, Dr. John Christian Jensen and
                    BioClin Institute of Clinical Pharmacology GmbH is
                    incorporated herein by reference to Exhibit 2.3 to the
                    Company's Current Report on Form 8-K filed on August 19,
                    1996.

         (xxxv)     Term Loan and Security Agreement, dated as of August 29,
                    1997, among the Company , Chrysalis International
                    Preclinical Services Corporation, Chrysalis DNX Transgenic
                    Sciences Corporation, Chrysalis International Clinical
                    Services Corporation and CoreStates Bank, N.A.

         (xxxvi)    Promissory Note in the principal amount of $5,000,000, dated
                    August 29, 1997, made by the Company, Chrysalis
                    International Preclinical Services Corporation, Chrysalis
                    DNX Transgenic Sciences Corporation and Chrysalis
                    International Clinical Services Corporation, to the order
                    of CoreStates Bank, N.A.

         (xxxvii)   Security Agreement, dated August 29, 1997, among the
                    Company, Chrysalis International Preclinical Services
                    Corporation, Chrysalis DNX Transgenic Sciences Corporation,
                    Chrysalis International Clinical Services Corporation and
                    CoreStates Bank, N.A.

         (xxxviii)  Stock Pledge Agreement, dated August 29, 1997, between the
                    Company and CoreStates Bank, N.A.

         (xxxix)    Collateral Assignment of Contracts, dated August 29, 1997,
                    among the Company, Chrysalis International Preclinical
                    Services Corporation, Chrysalis DNX Transgenic Sciences
                    Corporation, Chrysalis International Clinical Services
                    Corporation and CoreStates Bank, N.A.


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<PAGE>   64
         (xl)     First Amendment to Term Loan and Security Agreement, dated
                  September 24, 1997, among the Company, Chrysalis International
                  Preclinical Services Corporation, Chrysalis DNX Transgenic
                  Sciences Corporation, Chrysalis International Clinical
                  Services Corporation and CoreStates Bank, N.A.


-----------------------------
                  *Management contract or compensatory plan or arrangement
                  required to be filed as an exhibit pursuant to Item 14(c) of
                  Form 10-K.

(21)     Subsidiaries of the Company

(23)     Consent of Experts

         (i)      The Consent of KPMG Peat Marwick LLP regarding the Company's
                  Registration Statement on Form S-8 (File No. 33-49124) and
                  Registration Statement on Form S-8 (File No. 33-70976) is
                  attached hereto as Exhibit 23(i).

(24)     Powers of Attorney

(27)     Financial Data Schedule


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